Have we seen this story before? Black Monday 30 years later

Published October 23, 2017
IN THIS Oct 19, 1987 file photo, traders on the floor of the New York Stock Exchange watch monitors for transactions.—AP
IN THIS Oct 19, 1987 file photo, traders on the floor of the New York Stock Exchange watch monitors for transactions.—AP

HOW long can this nirvana last for investors? The stock market keeps ticking methodically higher into record territory, and the Dow Jones industrial average closed above 23,000 for the first time on Wednesday.

It’s been nearly 16 months since S&P 500 index funds had a pullback of even five per cent over the course of days or weeks, the longest such streak in two decades.

Many analysts expect the market to keep climbing, at least for the next year. The global economy is improving, corporate profits are rising and inflation remains low but not so low that it makes economists nervous.

But as investors learned so painfully 30 years ago, markets can shift quickly. On Oct 19, 1987, the S&P 500 plummeted 20.5pc to wipe out what had been sizeable gains for the year.

Virtually no one is predicting a repeat of “Black Monday”, which was the stock market’s worst day in history and happened when conditions were different from today. But several worries are circulating underneath the market’s placid surface. While they may not cause a 20pc drop in one day, they could be the spark for the market’s next drop of 5pc or more, whenever it ends up happening.

Here are a few potential stumbling blocks for a stock market that’s more than tripled since its 2009 bottom in the Great Recession, including a surge of 20pc over the last 12 months:

— Stocks are expensive. Even the most optimistic analysts wouldn’t call the market cheap. Stock prices tend to follow the trend of corporate profits over the long term, but stocks have been rising more quickly than earnings recently. The S&P 500 is trading at 31 times its average earnings over the last 10 years, after adjusting for inflation, according to data compiled by Yale economist Robert Shiller. That’s the highest level since the summer of 2001, when the dot-com bubble was deflating.

What if the stock market plunged 20pc tomorrow? The question may seem absurd when the market is in the midst of one of its calmest runs in history and at record highs. But it’s what investors had to deal with 30 years ago, when ‘Black Monday’ blasted stocks on Oct 19, 1987

By themselves, stock prices rising faster than earnings aren’t enough to cause markets to buckle. The stock market stayed at or above this level of price-to-earnings for years following the summer of 1997. But they’re enough to give some strategists pause.

— The Fed is tightening. The Federal Reserve slashed short-term interest rates to near zero in response to the 2008 financial crisis. It also took the unprecedented step of purchasing trillions of dollars of bonds to keep rates low. Those low rates meant bonds were paying little in interest, and investors moved into stocks in search of greater returns.

Now the Fed is slowly pulling back. This month it started paring back its $4.5 trillion in bond investments. And many investors expect the central bank to raise short-term interest rates at its meeting in December, which would be the third increase this year.

— The leadership of the Fed may soon change. Janet Yellen’s term as chair of the central bank expires in February, and whoever sits in the seat next will have great influence over how quickly the Fed moves. President Donald Trump said he’ll likely choose from a field of five candidates, one of whom is Yellen.

Many analysts and investors expect the next chair to stick to the Fed’s announced schedule for bond-investment reductions, but any uncertainty could unnerve investors.

— Tax reform may fail, or the dollar may jump in value. Stocks have recently received a boost from rising expectations Washington will be able to cut tax rates. Lower taxes could mean bigger profits for companies and likely launch another round of stock repurchases by businesses. But if Washington stumbles, the disappointment could drag down stocks.

Strategists at Goldman Sachs say the S&P 500 may end the year at 2,650 if tax reform passes, which would be a roughly 3.5pc gain from Tuesday’s close. But if reform doesn’t happen by then, the index may end the year at 2,400, down 6.3pc from Wednesday’s close of 2,561.26.

If the dollar jumps in value, meanwhile, it would cut into the profits that multinationals have been making from their overseas sales.

— North Korea and other hotspots around the world remain big unknowns. Analysts call this “geopolitical risk,” and one of the reasons it’s so scary for investors is that it’s not possible to predict.

“There are a lot of dangerous things going on,” said John Vail, chief global strategist at Nikko Asset Management. Besides the worsening war of words between North Korea and the United States, he listed Ukraine and Syria as other areas with the capability of drawing the world’s big powers into conflict.

So far, investors have shrugged off such worries, but for how much longer?—AP

Published in Dawn, The Business and Finance Weekly, October 23rd, 2017

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