Thirty years ago today, global financial markets experienced their first meltdown of the contemporary era. Known as “Black Monday”, October 19, 1987, saw the Dow Jones Industrial Average (DJIA) drop 22.6%, which to this day remains the second-largest percentage loss in its history (a 1916 loss of -24.39% holds the top spot). The crash was proceeded by a strong bull market during the first part of 1987, gaining +44% by late August. Concerns about a “bubble” began to build and beginning in mid-October, a string of events began to unfold. The problems started with U.S. data that showed a larger-than-expected trade deficit, which sent the dollar tumbling. Stock markets around the world began experiences significant losses on October 14. On the 15th and 16th, Iran struck two separate tankers with silkworm missiles, both of which had U.S. ties. Also on Friday the 16th, London markets were unexpectedly closed due to what became known as the Great Storm of 1987. Over the following weekend, U.S. Treasury Secretary James Baker voiced concerns about the market declines that were being witnessed around the world, and also threatened to devalue the U.S. dollar in order the narrow the country’s trade deficit. Before Wall Street opened on Monday, Asian markets had already taken a deep dive. U.S. traders had sell orders already lined up before the market even opened, which sent the Dow into a downward spiral. It ended down -508 points. Markets around the world also experienced deep losses, including New Zealand (-60%), Hong Kong (-45.5%), Australia (-41.8%) and Canada (-22.5%). It was at this point in contemporary history that the financial industry realized how “globalized” the world had truly become. “You learn how interrelated we all are and how small we are,” said Donald Marron, chairman of Paine Webber, at the time a prominent investment firm. “Nowhere is that exemplified more than people staying up all night to watch the Japanese market to get a feeling for what might happen in the next session of the New York market.” The crash was partially blamed on a new product in the U.S. known as “portfolio insurance”, which involved the extensive use of options and derivatives. Market losses triggered “program selling”, or what we today refer to as algorithms. Further stock losses led to more computerized selling, creating a downhill snowball effect. Afterward, some economists theorized the speculative boom leading up to October was caused by program trading, and that the crash was merely a return to normalcy. A surge in international investors also caught part of the speculative bubble blame. Regulators also identified some structural flaws which they worked to fix in the aftermath. At the time of the crisis, stocks, options, and futures markets used different timelines for trade settlements, which during periods of rapid trading could lead to negative trade balances and force liquidations. The markets also didn’t have any rules to halt trading temporarily in the face of steep price declines, known now as “circuit breakers.” For example, under current rules, the New York Stock Exchange will temporarily halt trading when the S&P 500 stock index declines 7 percent, 13 percent, and 20 percent in order to provide investors “the ability to make informed choices during periods of high market volatility.” Despite the very scary sell-off, markets rebounded over the following two sessions, regaining 288 points. It did however take almost two years for stocks to surpass their pre-crash highs. (Sources: Federal Reserve, Wikipedia)
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