Lessons of the 1987 Stock Market Crash

Is Dow 23,000 a reason to celebrate or a warning signal of a stock market correction, or even worse, a crash? Perhaps it's a little bit of both. The International Monetary Fund recently upgraded its global growth projections, but also issued a caveat, noting that the economic bounce back was breeding “complacency,” that was “spawning financial excesses...While the waters seem calm, vulnerabilities are building under the surface [and] if left unattended, these could derail the global recovery.” Amazingly, these words could have been the exact same warning from ten or thirty years ago.

Just as global markets are reaching new highs, we are marking the thirtieth anniversary of the Crash of 1987, aka “Black Monday,” which occurred on October 19, 1987. That day, the Dow Jones Industrial Average cratered by 508 points or 22.6 percent, making it the single worst one-day percentage loss Wall Street has ever suffered -- the next closest was a 12.8 percent loss in 1929. To put that in today’s terms, that would be as if tomorrow, the Dow fell by more than 5,000 points in a single session.

Sadly, the magnitude of the 1987 crash was soon forgotten, according to author Diana Henriques. Her latest book, A First-Class Catastrophe: The Road to Black Monday, the Worst Day in Wall Street History. When I recently interviewed her, Henriques explained how Black Monday “was the product of profound but poorly understood changes in the shape of the marketplace over the previous decade.” There were missed opportunities, market delusions, and destructive actions that stretched from the silver crisis of 1980 to regulatory turf battles in Washington and even a bitter rivalry between the New York Stock Exchange and the Chicago Mercantile Exchange. The upshot was a crash that might have been prevented and a financial crisis that was only stopped because of the Herculean effort of a few key players of the time.

Sound familiar? As I read Henriques’ book, I was plagued with queasy memories. The crash occurred during the first month I was a trader on the floor of the Commodities Exchange of New York. I was also reminded how investor memory can be fleeting. You would think that after Black Monday, lessons would be learned on every level--in government regulatory oversight; on Wall Street where opaque and misunderstood financial products purchased with borrowed money can spark a contagion; or by retail investors, whose emotions allow them to get swept up into bull markets.

But in her analysis, Henriques demonstrates how Black Money was the predicate to the financial crisis of 2008. Sadly, investors, regulators, and bankers failed to learn from the pain of 1987, even as the same patterns resurfaced. And today, the regulatory system remains Balkanized and all of the “major mutations that were central elements of the Black Monday crisis have been more deeply embedded in Wall Street’s genetic code.”

Henriques also notes something that we all know about ourselves: we don’t cope particularly well in a crisis – most of us panic. While it is nearly impossible to predict a crash, the following aphorisms might be worth revisiting:

Cash is King: An ample emergency reserve fund of six to twelve months of living expenses can do a long way in calming the nerves and reducing the urge to sell at the bottom. For those near or already in retirement, a cushion of one to two years is advisable.

Planning is Queen: A thorough financial plan that contemplates both good and bad markets can help you navigate a crash and its aftermath. Returning to the plan in times of volatility can help remind you of your long-term goals.

Diversification and rebalancing complete the Royal Family: Understanding your risk tolerance to build a diversified asset allocation for your investments, followed periodic rebalancing, can help protect your money when the next crash occurs.