As you saw in Part 2, there was a well-established mania by the Summer of 1987. But the cracks became much more visible as we entered October 1987.
The US central bank (now led by a young-ish Alan Greenspan) had raised interest rates in September to take some steam out of their economy, before inflation became a problem - on that day (9th September) the market fell 62 points, a very big fall for the time.
Bond markets were in a tizzy. At the beginning of 1987 the yield on US government bonds was a little over 7%, but by early October yields were up through 10%. To give this perspective, the long term return from the stock market was just about 10% per annum. After outsize returns in 1985 and 1986 the market was up around 40% in just 9 months - in contrast bonds now offered you a government-guaranteed return of 10%. Hmmm. What would you do?
It didn’t help that the widely followed analyst Robert Prechter gave a confident “sell” recommendation for the US stock market. The Dow Jones immediately responded with a record daily points drop at the end of the first week of October.
The next week start with a report in the Wall Street Journal citing concerns that the use of portfolio insurance “could snowball into a stunning rout for stocks” if the stock market began to fall. This was Monday 12th October - the falls were only hours ahead.
On Wednesday 14th the panic began to unfold as a legislation was introduced to severely limit tax deductions for interest paid on debt to finance takeovers - takeovers had played a key role in this latest manic phase, and were now under threat. Unhelpfully, a worse than expected trade deficit was also announced, and the dollar declined. The latter brought into focus the possibility of another interest rate increase, which again served to highlight the alternative attractions of the risk-free potential in bonds.
That Wednesday the Dow dropped 95 points (3.8%, a then record). On Thursday 15th the falls continued, another 58 points, and the Dow was now off 12% from the all-time high on 25th August. It was reported by the Wall Street Journal at the time that institutions were active switching out of the stock market into bonds. The size of the falls also triggered heavy selling by portfolio insurers, according to a later report (Brady Report, 1988).
In the UK on Thursday the UK stock market was relatively unperturbed by these events in the US. But that night the south east of England was hit by “The Great Storm of 1987”, which caused havoc as well as 13 deaths.
The UK stock market might have been closed on Friday 16th (I will explain why in a moment), but it was business as usual in New York, and it was ugly. Another interest rate increase triggered another record points fall in the Dow Jones on Friday 16th October.
Over that weekend there was pent-up panic in the UK
The UK newspapers might as well have been printed with black borders, as the death of the market was being widely predicted for Monday, similarly in the US media.
It is still fascinating looking back at the FT for that weekend (yes, we’re very sad people and retain copies that old!). Lots of adverts on how to make a killing investing, how to make a million, “Double your money in weeks”, and a flurry of new fund launches. There was no holding back the marketing departments of the fund management groups!
Before looking at what happened on Monday, let’s return to Friday, and our offices in Chislehurst.
The storm on Thursday night was punctuated by trees, corrugated iron, and random flotsam and jetsum flying past the bedroom window. It was also a restless night because during the day on Thursday we had decided to start selling client holdings, and put together a plan of action. By Thursday evening this seemed all the more urgent as the US markets closed down sharply again.
By first light on Friday it was clear that driving was impossible (most roads around Chislehurst were closed by felled trees), so we set out to clamber through the debris to reach the office.
Now the fun began...
On reaching the office on Friday morning we had a list of what we wanted to sell, and began ringing the fund management companies to do so – there were no convenient fund platforms at that time, nor online dealing. Mostly our phone calls went unanswered - no one even picked up.
There was no 24 hour news, no Sky, no Bloomberg, no internet. To keep up to date with markets we had a small transistor radio on the corner of the desk.
It quickly became clear that few people made it to work in London. But we persevered with our phone calls, and always remember our relief when Fidelity answered the phone, and took “sell” orders. Most offices remained closed, and later in the day it was announced that there would be an unofficial Bank Holiday, and the financial markets in the UK would remain closed on Friday 16th October.
At this stage it is worthwhile explaining a small technical matter
These days you know that if you give an order to sell a fund today, you do not know the sale price until tomorrow; the fund price tomorrow is calculated taking into account the movements in stock markets today. That obviously seems very fair, and is called “forward pricing”.
It was different in 1987, and considerably to the advantage of the investor in volatile markets. If we sold a fund that Friday we would typically receive a known price based on how the stock market moved yesterday, what was called “historic pricing”. Bonkers from today’s perspective, but a huge bonus that Friday.
We managed to reduce client exposures to stock markets, if not to the extent we would have liked.
After lunch on the Friday it became clear there was little more we could do, and the markets were now opening in New York. The news bulletins revealed that, following another interest rate hike in the US, the Dow Jones had fallen sharply again (down 108 points). It was the first ever one day fall in excess of 100 points - and it was still only Friday. That day there was more selling by portfolio insurers, retail investors were now selling funds, and some more aggressive institutions understood that this momentum was very likely to continue, so were selling futures to profit from this likelihood.
That weekend the UK (and US) newspapers were full of panic and stock market obituaries.
There was considerable pent-up selling pressure in the UK. Due to The Great Storm the UK stock market had not yet been able to respond to two horrible trading days in the US, let alone their interest rate increase and a painful new tax reform to discourage takeovers.
All the elements were in place for a crash worthy of the name on Monday 19th October 1987. But there was still no sense of quite how bad it would be.
Black Monday arrives
Monday 19th October was horrible. The FTSE 100 index plunged 249.6 points by the close, and was down a further 250.7 on Tuesday. The UK stock market fell by 21.7% in total over the 19th and 20th October.
When the US market opened on Monday it was now following the mood (of panic) in the UK, rather than the other way around. On Black Monday alone the Dow Jones fell 22.6%, nearly twice as much as the equivalent day in 1929. This mayhem prompted one of our favourite quotes from the period, by M&G’s David Tucker, who said this was:
“..the sort of thing you get when you put computers in place of people. Computers can’t go out to long lunches - which is what I’ve just done”
As the mania had developed in 1986/7, the better informed were drawing parallels with the 1929 Crash, beginning with Galbraith early in 1987. They well knew that the appalling Great Depression followed the 1929 Wall Street Crash, and that the stock market took 25 years to regain the levels of 1929.
As such it was no surprise that many professionals took no chances, and they dominated the selling on Black Monday. In contrast, retail investors were transfixed, in our experience. Plus the fund management industry was, as one, not answering the phone - even if you wanted to sell your funds, there was no way you could do so on Black Monday (even though, unlike the previous Friday, markets were open for business).
On Monday in the US the market infrastructure was quickly overwhelmed as a sharply lower opening prompted more portfolio insurer selling. Significant selling continued throughout the day, with selling pressure later in the due encouraged by rumours that trading would be halted on Tuesday.
Alan Greenspan, new Federal Reserve boss, needed to be seen to act. Before the market opened on Tuesday he publicly announced that the Fed was ready to pump money into the economy and the markets to stop the Wall Street rout. An extraordinarily turbulent day followed in the US, again full of rumours and a mood of panic. Then something happened after lunch - back to Manuel Johnson (see Part 2
“Luckily, and this is a mystery still today, at some point
when the market got low enough some institution which
we have never really identified started buying.”
That day the US market eventually closed up by a record 5.9%.
There was no Great Depression II.
Remarkably, the FTSE 100 index closed the year up 2% (though still off 30% from its July peak).
With the benefit of hindsight it is easy to ask “what was the fuss?”. After all, the US and UK markets had fully recovered within two years - but that is hindsight.
Concerns persisted. In the New York Times in December 1987 a survey of 33 eminent economists concluded “the next few years could be the most troubled since the 1930s”. We can call economists perpetual worryguts - perhaps they worry that they have nothing to contribute unless they are worrying about something.
Yet for many hard-nosed traders this was these were the most dramatic couple of days of their careers, even taking into account the more recent financial crises.
What went wrong?
There is much more on this in the full e-book. For now it can be boiled down to this.
By the Summer of 1987 the elephant in the room was one simple investment question, which can be laid against a very clear back-drop:
The average annual return from the stock market is approximately 10%.
In 1985 the UK stock market went up 14.7%...
...in 1986 it grew by 18.9%...
...and in the first 7 months of 1987 it went up by more than 40%.
By Summer 1987 a guaranteed return of 10% was available from
What should you do?
The question was answered on 19th and 20th October 1987.