Thirty years after Wall Street lost almost a quarter of its value in a few hours, should investors brace themselves for another crash
Is Black Monday about to strike again?
On October 19, 1987, , global stock markets suffered the most spectacular one-day crash of all time.
The day is known as Black Monday, when US stocks lost almost a quarter of their value in a few panic-filled hours. The Dow Jones Industrial Average fell 22.6 per cent, wiping an astonishing $500 billion off share values.
This was more brutal than Black Monday, 28 October 1929, when the Dow fell 12.8 per cent.
Worryingly, a growing number of analysts are warning that October 2017 could deliver a repeat performance, as there are similarities.
Global stock markets are riding at all-time highs amid widespread concern about valuations, as they were in 1987, and in 1929. Should investors be ready to paint it black again?
What caused 1987?
The 1980s were the years of Thatcherism and Reaganomics, as British prime minister Margaret Thatcher and US president Ronald Reagan liberated markets and drove through free-market reforms.
In October 1986 the City of London was deregulated, turning it into a financial capital to rival New York.
Investors were making big money, and everybody was jumping on the bandwagon. The Dow Jones average of 30 industrial stocks rose a dizzying 27.66 per cent in 1985, then another 22.58 per cent in 1986.
By August 1987 the US market was up a further 40 per cent, but then investors started to worry that shares were overvalued.
Gaurav Kashyap, a market strategist at EGM Futures in Dubai, says the initial sell-off began on the preceding Wednesday. “New data showed the US trade deficit widening, and reports suggested the House of Representatives was planning to eliminate tax breaks on mergers, which were driving much of the growth."
As share prices fell, new electronic trading systems automatically liquidated stock holdings once they hit a certain level. Portfolio insurance designed to minimise losses instead created a vicious cycle of selling.
Markets fell again on Thursday and Friday, and the weekend newspapers were full of gloom.
British wealth manager Brian Dennehy, managing director of financial advisers Dennehy Weller, remembers that anxious weekend well. “The newspapers effectively wrote the obituary for global stock markets. Black Monday followed.”
It's a different world to the one we know now, he says. “There was no 24-hour news, no Sky, no Bloomberg, no internet. We kept ourselves updated using a small transistor radio.”
Is it about to happen again?
Mr Dennehy now sees plenty of parallels given today’s "horribly inflated” US stock market, and he is not alone.
This year, the world is in another bull market, one that has been on the charge for more than eight years, amid mounting concern.
In August, Goldman Sachs said share prices are "elevated valuation on almost every metric”. Wall Street giants HSBC, Citigroup and Morgan Stanley have also reported mounting evidence that global markets are in the final stage of their rallies.
Steven Downey, chartered financial analyst candidate at Holborn Assets in Dubai, says investors are right to feel uneasy, given that today’s stock market appears vastly more overvalued than in 1987. “The Shiller PE measure of stock market valuation peaked at 17.5 in the run-up to Black Monday. Today it sits at 31.”
It has only hit this level twice before, in 1929 and the dot-com bubble of 1999.
Mr Downey says there is potentially scope for a large correction. “However, others argue that today's low interest rates make today's market valuation quite rational.”
He says you should resist the temptation to cut and run. “It is impossible to see all the potential catalysts for a market drop. We cannot see clearly into the future and there will always be surprises. Volatility is the price you pay for stock market outperformance.”
What is the outlook now?
Chris Beauchamp, market analyst at IG Index, which has offices in Dubai, says we may get a clearer picture in the next few days, as we enter company reporting season in the US. “Equity markets look ripe for a drop should earnings disappoint. This is hardly the time to be chasing a stock market that is currently trading at all-time highs.”
However, Mr Beauchamp remains positive. “It may take a lot more than just some bad numbers to really hit this seemingly-invincible bull market."
The big concern is that central bankers, headed by the US Federal Reserve, are now looking to unwind years of monetary stimulus.
Rock bottom interest rates and trillions of dollars worth of quantitative easing (QE) have inflated asset bubbles all over the world, and these could pop if the Fed and European Central Bank take action to reverse the trend.
Mark Taylor, chief customer officer at online investment platform SelfTrade, says asset bubbles inflated by years of monetary stimulus have combined with rising personal and government debt to knock investor psychology.
Others note that the last two large market corrections occurred in a year ending with the number seven: October 1987 and the financial crisis in 2007. “You do not have to be superstitious to notice that stock markets broadly operate in 10 to 20 year cycles,” Mr Taylor adds.
China is another concern, as the country's economic miracle appears to be sustained by ever spiralling levels of debt.
What action should investors take?
Sam Instone, chief executive officer at wealth managers AES Investments in Dubai, says investor sentiment today echoes 1987. “Investors were already fearful in the run up to Black Monday and fear quickly turned to panic as the market started to drop. They are also twitchy now, with the market riding so high.”
Mr Instone says that anybody who invests in the stock market must accept that things will get bumpy from time to time. “There will always be corrections and crashes, and there will always be periods of recovery.”
One thing you cannot do is to predict when the next crash will happen, as timing the market is beyond even the most expert investors.
So do not rush to sell all your stocks and mutual funds because as Mr Instone points out: “They key to successful investing is to invest money as soon as you can, stay in the market whether it’s going up, down or sideways, and remain there for the long-term.”
Mr Instone says treat warnings of a market crash with scepticism. “If you are investing for at least five years and preferably 10 years or longer, and you can simply wait for markets to recover."
He says for the vast majority, the best way to invest is to build a globally balanced portfolio of low-cost passive stock market trackers such as exchange traded funds (ETFs), and hold them to retirement and beyond.
Another danger with selling up in advance of a rumoured crash is that you then face the equally difficult decision of when to buy back into the market. By buying and selling in this way you will also will rack up trading charges, which eat into your profits, and miss out on any company dividends while out of the market.
Expert day traders can make money this way – and lose it just as quickly – but most ordinary investors should not even try.
Mr Kashyap says that those who do like to trade more sophisticated investments, such as futures and options, should avoid overexposing themselves and risking more money than they can afford to lose. “Provided you have the necessary capital, you can ride out the storm.”
He warns that some irresponsible brokers have sold very high leverage options to clients, where one sudden market move sees the client lose all their capital and possibly even more. “You need to work closely with your broker to reduce exposure and manage risk.”
Can a crash be turned into an advantage?
Traders can turn a market crash to their advantage, Mr Kashyap adds. “Markets recovered quite nicely after Black Monday and this allowed some investors to buy lower, reducing their average buying price, and cash out with much higher profits when markets recovered.”
Mr Kashyap believes markets will slow as the Fed tightens and reduces market liquidity, but does not expect a severe sell-off. “The slowdown should not be panicked or uncontrolled or unexpected.”
Will we see another Black Monday in October 2017? Or Tuesday, Wednesday, Thursday or Friday? One day, we will. The problem is that nobody knows when that day will be. Provided you are invested for the long term, you can afford to sit tight until markets recover, as they will, which is the true lesson of Black Monday.
Remarkably, global stock markets actually ended 1987 year at a slightly higher level than they started it.
The global bull run then resumed as if nothing happened, with the Dow leaping 11.85 per cent in 1988 and 26.96 per cent in 1989, before powering on through 1990s. Markets always recover in the end, no matter how black the short-term outlook.