1987’s Black Monday, But What Did We Learn?

4th of November, 2017

It was the stuff movies are made of. White knuckled brokers frantically screaming “Sell, Sell, Sell” – desperately seeking any offer they could. The problem was, there was no one willing to take the other side – not even a whimper of a “buy”.

The tsunami of selling wiped a staggering 25% or $65B off the Australian Stock Market in one day.

Stunned stockbrokers just stopped answering phones amidst the chaos that surrounded them.

It was the era of the corporate raider. The quintessential Fat Cats, riding high and flushed with cash. Borrowed loot – anyone’s cash but their own.

Christopher Skase had bloated Qintex. Rodney Adler was wrecking FAI Insurance and Bond had the trifecta, the Americas Cup, Cash and his memory…….

Both the Dow Jones and the S&P 500 had lost more than 9% over the preceding week.

But that Black Day in October finished it all.

“The Australian stock exchange created an index called the entrepreneurial index which made up 10 per cent of the market by capitalisation on the first of October 1987 — at the end of ’87 it was worth zero, nearly all the entrepreneurs had gone under,” Geoff Wilson, Wilson Asset Management

The party had stopped for everyone – except Paul Keating who still got his “Recession we had to have”.

Carnage everywhere. It was amazing the chalkies didn’t have to switch to red chalk!

Ronald Li, the then Chairman of the Hong Kong Stock Exchange closed the market for a staggering 4 days trying to both stop the massacre and deal with the masses of defaulting brokers (most of whom were later bailed out by the government!)

Trying to find answers, President Ronald Reagan set up a taskforce to examine the 1987 Crash and it came to the determination that the cause of this disastrous set of events were:

• High merchandise trade deficit
• A tax proposal that might have made some corporate takeovers less likely
• Portfolio Insurance

The report stated the “initial decline ignited mechanical, price-insensitive selling by a number of institutions employing portfolio insurance strategies and a small number of mutual fund groups reacting to redemptions”.

Portfolio Insurance[1] rightly or wrongly is often blamed for the 1987 crash.

Portfolio insurance is a form of program trading where stock futures are automatically sold as prices fall – placing further downward pressure on prices. In a panicked market this can become self-fulfilling, exacerbating the price decline.

Portfolio insurance was no revolutionary invention, just an easy way for institutions to sell a portfolio if a market starts to fall. Sounds like a plain old stop-loss order?

“No one planned for the Poseidon correction, no one planned for ’87 and no one planned for the GFC,” – Campbell Neal

Such “lessons” provide us with NO more useful knowledge or tools other than to say all you need to do is “Buy low and Sell high”

The markets are no more evolved than what they were 200 years ago. Sure, we have faster technology. More complex instruments. Regulators and Watchdogs. But two things have NOT changed.

The Economic Drivers, and the Participants.

Humans are still wired for a fight or flight response. Fear and Greed is just a manifestation of this.

So, what have WE learned?

There is a definable and reliable economic cycle that we need to use as a framework of thinking, to guide our decision making.

As we always say, each cycle is “SAME – SAME, but different”

“No-one had a frickin’ clue this crash (1987) was coming, and no one talked about it before it happened, I can tell you that as well,”. PM Capital founder Paul Moore

Let history be a guide. Remember “History doesn’t repeat but it rhymes at times”

30 years on, the October 1987 Crash is but a distant memory. Few in funds management are old enough to have lived through the event and the old guards, having long retired, are now living the existence of travelling Grey Nomads.

Those involved now think they are too smart for any such shenanigans to derail their illustrious financial careers. So, although they have expunged the possible outcome of a Crash from their quant models, I personally would ponder a little longer on the rhyming times.

We love the stock market and the opportunity it creates. People say that you can’t forecast financial markets. What they are really saying is that “THEY” can’t forecast financial markets.

We CAN and we do it every year. Publicly and in print so that there can be no argument as to what we said.

So come and peer into the future with us at our Forecasting Conference – we would love to share our view of the future with you.

[1]Portfolio insurance is a method of hedging a portfolio of stocks against the market risk by short selling stock index futures.

This hedging technique is frequently used by institutional investors when the market direction is uncertain or volatile. Short selling index futures can offset any downturns, but it also hinders any gains.

Portfolio insurance is an investment strategy where various financial instruments such as equities and debts and derivatives are combined in such a way that degradation of portfolio value is protected. It is a dynamic hedging strategy which uses stock index futures. It implies buying and selling securities periodically in order to maintain limit of the portfolio value. The working of portfolio insurance is akin to buying an index put option, and can also be done by using listed index options.

The technique, invented by Hayne Leland and Mark Rubinstein in 1976, is often associated with the October 19, 1987, stock market crash” https://en.wikipedia.org/wiki/Portfolio_insurance