This week marks the 30-year anniversary of “Black Monday”—the stock market meltdown that occurred on October 19, 1987. It was the biggest ever single-day percentage decline with the DJIA (Dow Jones Industrial Average) falling 22.6%. What makes that day so significant is that is happened around the anniversary of October 28th, 1929, the original “Black Monday” stock market crash that ultimately led to the Great Depression.[1]

October has gotten a bad rap for being one of the most feared months—not only is it a time when people are encouraged to scare each other, it’s also been a time that is historically bad in finance. Since 1987, there have been seven stock market crashes that have occurred in October.[2] While this may instill some panic for investors, there are many reasons to believe that this year is quite different from 1987.

Prior to the DJIA’s major crash in 1987, the S&P 500 was up almost 40% year to date. But even despite the 22% setback, the S&P 500 still finished positive, up 2% for the year.[3]

While this year has also seen an unprecedented run in the stock market, with new highs being reached consistently, much of this is attributed to positive earnings reports. Earnings growth in the last year can be tied to two factors: companies are arguably more efficient, and stock buybacks from many large corporations. Since 2010, it’s been estimated that companies have collectively spent over $3 trillion on stock buybacks. Stock buybacks can inflate earnings in the short-term, as corporations will use company cash to buy their own shares, thus creating a positive attitude towards trading. Also, historically low interest rates makes stocks more attractive when compared to bonds, which will have low yields. At the time in 1987, bond yields were much higher and seemed more appealing/less risky than a stock market with stretched valuations.

There are three major reasons why this year is different than 1987:

  1. Technology changes: in 1987, it was a relatively new concept to have computer systems that could make large-scale trade orders. As the market fell, stop-loss orders were triggered at a rapid pace, causing a domino effect that dragged the market further down.[4]
  2. Regulation changes: after the 1987 crash, the Securities and Exchange Commission (SEC) implemented “circuit breakers” that trigger a market-wide trading halt if it detects a decline of 10%, 20%, and 30% in the DJIA. These rules ensure more stability in the market in times of overreaction.
    1. Similar to the market-wide trading halts the SEC implemented for large declines in the major market indices, the SEC also mandated trading halts for any stock that that starts trading outside of a specific range based on recent prices. Therefore, if a significant drop is detected in a stock’s price, trading is temporarily stopped.
  3. Using history to guide trading strategies: We are also more aware of the history following major market declines. Below is a table of the S&P 500 after Intraday Drop of 7% or more going back to 1987. You can see that the index tends to wildly outperform 1 year after a major down day.[5]

Graph SP 500 7 percent drop

Source: Schaeffersresearch.com

So while a major run in the stock market can at times precede a major correction, more efficient technology, stronger regulation, and a more tactful trading strategies are just some of the measures taken to safeguard and help subside negative effects in times of market chaos.

 

An investor cannot invest directly in an index. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.

 

[1] https://seekingalpha.com/article/4113726-black-monday-30th-anniversary-forget-history?page=2

[2] http://www.investopedia.com/articles/financial-theory/09/october-effect.asp

[3] http://www.schaeffersresearch.com/content/analysis/2017/10/17/black-monday-anniversary-a-look-at-stock-market-meltdowns

https://www.forbes.com/sites/aalsin/2017/08/09/how-stock-buybacks-cause-economic-stagnation-a-qa-with-robert-ayres-and-michael-olenick/#4315109316dd

[4] https://finance.yahoo.com/news/could-1987-stock-market-crash-050919703.html

[5] http://www.schaeffersresearch.com/content/analysis/2017/10/17/black-monday-anniversary-a-look-at-stock-market-meltdowns

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