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The crash of 1987 provides some positive guidance today

Looking at the similarities between the 1987 crash and the current equity slump. Despite recent events, the longer-term conclusion is more positive.

by
Clive Worlock

23.04.2020

As Mark Twain is reputed to have said, “History doesn’t repeat itself, but it often rhymes”.

As a fresh-faced young stockbroker who had only joined the City in 1986, just ahead of ‘Big Bang’, 1987 turned out to be a pretty tumultuous year.

The 80s were exciting times, propelled by the ‘Thatcher revolution’, falling interest rates and inflation, a booming housing market, corporate restructurings and a wholesale sell-off of public utilities. Privatisations promised free money for all investors, households made multiple applications for successive state share sales (including for pets Fido and Tiddles) and brokers’ back offices buckled under pressure, as everyone wanted a piece of the action.

Stock markets were on a tear and, in 1987, the investing public went all-in. Speculation was rife and participants dreamed of getting rich quickly. Wine bars overflowed with champagne-swilling brokers enjoying the good times and looking forward to receiving their fat bonuses at the year-end.

By mid-July 1987, the FTSE 100 Index was up 45% in the year-to-date – and even my estate agent friend next door was asking me about buying shares (he subsequently proved to be an excellent contra-indicator for market tops and bottoms). The market was doing so well that he decided to trade up from his Golf GTI to a Porsche 911. The markets dipped for a few weeks but rallied again into October – just falling short of the July high before coming slightly off. Nothing could have braced us, however, for the events that subsequently unfolded.

The end of hubris

US markets had fallen by nearly 4% on Wednesday 15 October and fell again the following day, bringing the market some 12% off its August high. Panic began to set in. In the meantime, the weather storms of 1987 (of classic Michael Fish fame) hit the UK on Thursday night and I recall waking up on Friday morning with no power, TV or radio – but getting dressed otherwise normally for my daily commute.

Coming out of our road I observed a tree had fallen and, when I got to the station, there were no trains running so I started looking forward to an enforced long weekend instead. The UK stock market closed due to the complete dislocation of the country’s infrastructure, but when the US market opened it plunged another 5%.

By the time UK markets reopened on Monday, the UK was playing catchup with the US. I had never witnessed anything like it. At the 9:30 open, the FTSE 100 had fallen 6% and, when the US markets opened that afternoon, the accumulated back orders from the weekend rapidly propelled prices even further south. The US stock market closed down a colossal 22.8% that day, earning the moniker “Black Monday”.

Within two days the UK market had fallen a staggering 23%. I recall everyone in the office just staring at their price screens, caught like rabbits in the headlights, completely unable to process what was happening and not knowing what to do.

The parallels are there

Now, what does all this have to do with the current market sell-off you may well ask? These are completely different times and circumstances and yet, if you look back in history, 1987 is among the few “instant bear markets” to analyse – the most famous being the 1929 Wall Street Crash.

US S&P500 Index - Similar to 1987

Research house MRB Partners believes that fears in 1987 were partly driven by concerns that the price-inflation spiral of the 1970s might return, choking off growth. However, this time around investors fear the opposite, namely a deflationary slump on the back of the Covid-19 pandemic. They also fear that the central banks have run out of ammunition, having spent it all during the Global Financial Crisis some ten years previously.

If you overlay 1987’s chart with the current day, it is striking just how similar the speed and duration of the declines are. Further, if you compare the current market – both to 1987 and other, more conventional, bear markets over the last several decades – you also can’t help to conclude that the current episode is far more similar to the 1987 sell-off than any other bear market in post-war history. The chart below, courtesy of JP Morgan, illustrates the point effectively.

S&P 500 Drawndowns in Downturns

Given the similarity of the market price action, what can we learn as investors?

The first point to make is that when markets move so rapidly, they defy logic and reason. As market participants, we all rapidly switch into “fight or flight” mode. We can’t avoid it; it’s just the way humans are wired. As it’s never a good idea to try and stand in the way of a moving freight train, sitting on the sidelines and waiting for some calm to be restored is a good starting point – and one that most professional investors (note investors not traders) would advocate.

What the recovery comes

As volatility starts to return to normal, this usually coincides with the market bottoming process and, as investors, we can then start to take stock of the situation, rationalise what is happening, consider the prospects for recovery, establish which are the likely winners and losers and make the appropriate adjustments to investment portfolios.

Often, at stock market bottoms, the index will rally from the low and go back to “re-test” it and, provided that the original low holds, it will then go on to form the base of the next bull market. This is a great example of technical analysis (charting) that I studied after the 1987 crash to understand the market dynamics more clearly and I have continued to use it successfully ever since (even if I failed to spot the crash of 2020 coming!).

ARC Sterling Steady Growth PCI - Drawdown Profiles

Asset Risk Consultants (ARC), providers of peer group performance indices for the private client asset management industry, has published its commentary on the current situation and it too has overlayed the current chart to the 1987 episode. Their chart (above) shows the 1987 pathway of recovery which took markets just 18 months to recover back to their former highs. If history does indeed rhyme, we may have a lot to look forward to after all.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

 

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