You know the guy who was thrilling in high school but turned out to be dull, except for his starring role in class reunions.
If it keeps up the largely benign pattern of recent years, the once scary month of October could lapse into that sad state. October on Wall Street. Oh, yeah, I remember when …
This month marks the 20th year since the 1987 stock market crash, when the Dow Jones industrial average lost nearly 23 percent on a single day, Oct. 19.
The problem with ’87 crash anniversaries is there’s not a lot to say. Market conditions are so different they have muted the relevance of the crash’s causes and effects.
Among today’s new factors are relatively low interest rates, greater participation by individual investors through systematic investing, globalization of investments and strides in trading capacity and technology.
No thoughtful person would say the stock market won’t suffer more plunges.
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“Crashes occur when everybody gets on one side of the market,” technical analyst Philip Roth of Miller Tabak said at seminar on the ’87 crash on Tuesday at the Chicago Board Options Exchange.
“There is something unknown out there that is going to get you,” veteran trader Blair Hull, chief executive of Matlock Capital, told the seminar.
Actually, a couple of hints of possible future shocks appeared in the summer’s subprime mortgage debacle.
Twenty years ago, financial markets were experimenting with investment vehicles comprising broad-based baskets of U.S. stocks, such as the Standard & Poor’s 500 index. Traders, in effect, could buy or sell the whole stock market in a single stroke. On Oct. 19, 1987, they sold.
Today, broad-based stock indexes represent a rock of stability, especially to the extent they are held for low-cost investing by pension funds and ordinary investors. This helps maintain equilibrium.
A new danger lies in the opposite direction: overspecialization. Investors chased greater returns in the subprime component of the total U.S. mortgage portfolio.
Banks accepted these concentrated bets as collateral for loans used to double down. Leveraged violations of prudent diversification spell trouble in the credit market, stock market or any market.
A second hint concerns the unexpected boldness of the Federal Reserve last month in slashing interest rates to counteract a seizing up of credit markets.
In the wake of the ’87 crash, the Fed abandoned its interest rate target and freely supplied cash to distressed financial firms needing credit. No one complained.
But in a brief passage on the role of the Fed, the 1988 Brady report ordered by President Reagan on the causes and lessons of the ’87 crash warned of “the danger that market participants may take more risk in the expectation that the Federal Reserve will bail them out in a crisis.”
Today, this warning is center stage, as public expectations of the Fed in managing financial crises have been magnified, perhaps beyond its ability to perform. Stock market mechanics have improved since 1987; human instincts have not.
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