Writers like to write about anniversaries, even gruesome ones. No one is suggesting that 1987 will happen today. Here’s Bob Pisani of CNBC on 1987:
October 19, 1987. That was the day the Dow Jones industrial average dropped 508 points, or 22.6 percent, the biggest one-day decline in the history of the stock market.
To put this in perspective, a similar drop in the Dow today would be almost 5,000 points.
That’s as much as the Dow has gained in the last 18 months, which has been one of the great market rallies of all time.
What was the fallout 30 years ago, and could it happen again?
There were many “causes” cited for the ’87 drop, including high valuations in the market (stocks had run up more than 40 percent that year), a too-strong dollar, and “portfolio insurance,” which hedges a portfolio of stocks against the market risk by short selling stock index futures. Staying long the market while at the same time shorting futures limits upside, but was also supposed to protect against the downside.
Except it didn’t. In a panic, futures and cash markets are linked. Selling in one begets selling in the other.
A presidential commission (the Brady Commission) was convened to figure out what happened, and while the authors placed the fundamental blame on portfolio insurance and “reactive selling by institutions” (i.e. they panicked), the commission also noted the drop was greatly exacerbated by what were called faulty market mechanisms, as well as “system failures,” and “intermarket failures”. These are polite ways of saying that traders were deluged with buy and sell orders that the trading systems could not handle.
Art Cashin, who was running the floor that day for PaineWebber, said that the situation felt “unreal.”
“Orders flowed in faster and faster and the tape ran later and later,” he said. That caused information to lag, which created more panic.
The commission concluded that the market structure could not handle the volume of selling: “Market makers possessed neither the resources nor the willingness to absorb the extraordinary volume of selling demand that materialized.”
The commission recommended that systematic circuit breakers be implemented across all exchanges, which would halt trading when the Dow hit certain percentage declines. They were adopted in 1989 and are still with us. These system-wide circuit breakers were triggered only once — on Oct 27, 1997, during the “Asian flu” crisis.
But there were other consequences. The ’87 crash accelerated the move toward electronic trading. The commission found that one of the main problems was the delay in trading caused by the pressure on trading systems that were not designed to handle such massive volumes. Tom Joyce, who was on the block trading desk at Merrill Lynch in 1987, told me “The Brady commission catalyzed a deep review of the markets that ultimately pushed the move toward electronic trading.” Electronic trading cut down the time to trade and increased available trading volume.
Could it happen again? Sure, the markets could have a big drop, and they have. The Dow dropped 1,000 points during the trading day in August 2015. But it’s unlikely to happen due to an inability of the market to handle the order flow, which the commission found was a very big contributing factor to the drop.
Portfolio insurance? It’s still around. Traders still go long stocks and short futures as a hedge. But it’s not done in a vacuum. There’s a much greater awareness of how interconnected the markets are today.
The bottom line: no one has repealed the laws of gravity. When a lot of people are looking to sell really fast, the markets will drop.
When my father was young
He put money into Mexico. It was a sure thing. It paid 13%.
A few years later Mexico defaulted and, well, you know the story.
Hence I’m amused by a story in yesterday’s New York Times: It talks of a raging interest in the debt of developing countries as a result of American interest rates being ultra low.
Popular destinations include Nigeria, Egypt and Tajikistan.
Comments the Times:
Of all of them, a recent $500 million bond offering by Tajikistan, a landlocked former Soviet republic that has rarely interacted with global investors, was the most curious. Tajikistan is paying investors an interest rate of just over 7 percent for 10 years, and the deal was a quick and easy sell for the country’s bankers, with demand several times the amount of money secured.
The half-billion dollars raised is especially staggering when compared with the size of Tajikistan’s economy. The cash influx represents 7 percent of its gross domestic product and dwarfs the $74 million the country holds in foreign exchange reserves.
“We were all scratching our heads over that one,” said Brett A. Rowley, an emerging market bond investor at TCW in Los Angeles, which passed on the Tajikistan bonds.
The article concludes:
In the past, these frenzies often ended in pain for all. Explaining why his bonds are a safe bet, Mr. Nnanna repeated a notorious maxim attributed to Walter B. Wriston, the chief executive of Citibank – made at the onset of the Latin American debt crisis in the early 1980s.
“Sovereign nations don’t go bankrupt,” Mr. Nnanna said. “And we are a sovereign nation.”
You can read the full article here.
More about our health. A reader writes:
+ Blue Cross Blue Shield just upped my friend’s monthly premium from $1,200 to $2,800. That’s a 2.33 times increase!
Travel
+ Hotels will give you 15% off if you book directly with them. The phone helps.
+ Some airline websites are just plain awful. Again, the phone helps.
A job that can’t be sent to Mexico.
I found this flyer in our apartment lobby.
News of dubious note
+ “If you see the equity market crack 4 or 5 points, buckle up, because I think we’re going to see a pretty interesting air-pocket, and I don’t think investors are ready for that,” Kyle Bass of Hayman Capital Management, warns.
What’s exacerbating the situation is the massively popular shift from active to passive investing over the years. That means risk is “in the hands of people who don’t know how to take risk,” the hedge fund manager says.
+ Marc Faber wrote in his October “Gloom, Doom and Boom” newsletter “thank god white people populated America, and not the blacks.”
+ President Trump told told Sergeant La David Johnson’s widow: “He knew what he signed up for.” For more, click here.
Sergeant La David Johnson
+ The aggressiveness of the security industry is amazing. You don’t need this:
I know this is funny. But I’m not sure why.
The Bulwer-Lytton Fiction Contest.
Since 1982 the English Department at San Jose State University has sponsored the Bulwer-Lytton Fiction Contest, a whimsical literary competition that challenges entrants to compose the opening sentence to the worst of all possible novels.
Two 2017 winners I like:
+ As Lewiston Creol plummeted down the sheer icy cliff he pondered on the word plummet, which quickly lost its meaning if you said it too much (plummet plummet plummet), but his pondering was interrupted by the surface of the water, at which point he ceased to plummet and began to plunge. – Jason Chandler, Saratoga Springs, New York
+ There’d been six of us at the outset, but after Smythe took a poisoned dart to the chest, Buddlestone fell from the top of a cliff, Stevens and Mayhew were swallowed by quicksand, and Tait-Harris was eaten by ants, only I remained to bring you our amazing tale.- Anna MacDougald, Winnepeg, Manitoba
You can read the rest here.
Harry Newton, who reports no more progress on bitcoin. Maybe tomorrow.
From an engineering perspective, the cause of the Great Crash and all subsequent flash crashes is simple – with the advent of multiple competing high speed computerized trading systems, the stock market has become the most complex control system on earth. It is far more difficult to predict than any other system because it is constantly evolving. What is remarkable is that there are not more such crashes. I believe that this is because of regulating mechanisms that have been put in place to limit the degree of decline once certain thresholds are met. But as any engineer knows, these mechanisms are not foolproof, and occasionally result in more catastrophic outcomes than if they had not existed. So keep a good stock of cash and probably gold also to ride out whatever may happen. And bear in mind that while the short -term gyrations of the market are dictated by illogic, long-term there is a reversion to rationality. Except for BITCOIN.
In another post I will tell you the story of the Harvard statistics grads – but too long for now.