3 Lessons from the 1987 Crash

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3 Lessons from the 1987 Crash

This Wednesday, October 19th, marks the 35th anniversary of the 1987 stock market crash.  I (Nick) was working as a customer service representative at the old Alliance Capital (now AllianceBernstein) that day.  I have, therefore, had a lot of time to reflect on how October 1987 changed investor perceptions of how markets function. 

To our thinking, these are the 3 most important things that came out of October 1987 and how they apply to today’s markets:

#1: The Fed Put.  This is the idea that the Federal Reserve will support equity prices during a crisis.  The day after the 1987 crash, then-Fed Chair Alan Greenspan released a statement that said:

“The Federal Reserve, consistent with its responsibilities as the Nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.”

That may read like boilerplate to the 21st century investor, but I can assure you it was very dramatic in its day.  Chair Greenspan was essentially saying “the Fed will not let 1987 become another 1929/Great Depression”.  This was the birth of the “Fed Put”.

Many market participants are wondering where the Fed Put might come into play this year. With the S&P 500 off +20 percent YTD and volatility abnormally high, it is a logical question.  Our view is that it will take far more stress in the financial system before the Fed considers a more market-friendly stance for monetary policy.  Inflation remains their key concern, not asset prices. 

#2: Markets crash from oversold conditions, not when they are overbought.  I first heard this bit of traders’ wisdom 20 years ago, and it absolutely fits with the 1987 experience:

  • US equities had a bad 3-day streak going into the day of the crash, with the S&P down 3.0 pct on October 14th, -2.3 pct on the 15th, and -5.2 pct on the 16th. This sequence went from Wednesday to Friday, for a total 3-day decline of 10.2 percent.
  • The October 19th crash was the following Monday, with the S&P down 20.5 percent on the day.

#3: Another piece of trading wisdom has it that stock prices need to retest crash lows before moving more sustainably higher, and the 1987 history fits that pattern:

  • The S&P would bounce back over the next 2 days after October 19th, by 5.3 pct and 9.1 pct respectively.
  • Even still, the following Monday was rough (S&P -8.3 pct).  As a result, the index was essentially unchanged from its October 19th crash close (224.8) to its close a week later (227.8).
  • The S&P did not bottom until December 4th, at 223.9. It then went on to rally 10.3 percent into year end.

The upshot from these 2 points is that market crashes don’t come out of the blue and investors need some time after such an event to recover their confidence in asset prices and economic stability.

Takeaway: although crashes are – by definition – very unusual events, every investor should have a playbook for such an occurrence because in the heat of the moment it is very hard to think clearly.  In the current investment environment, the key parts of that plan are:

  • Watch to see if a major down move for stocks forces the Fed to change its guidance on future interest rate moves. If it does not, stocks may not stabilize as they did in 1987.
  • If the Fed does change its view, then expect a short-term bounce in stock prices.
  • Don’t, however, be in a rush to buy; the 1987 history shows that investors will want to see a retest of the lows before believing the worst has passed.

Sources:

Federal Reserve history of 1987 Crash: https://www.federalreservehistory.org/essays/stock-market-crash-of-1987