Singing the Black Monday blues: Lessons from a crash the world didn’t see coming

 
Lucy O’Carroll
One Month's Rainfall Expected In One Day
There are echoes of 1987 in the current state of financial markets (Source: Getty)

Financial crises and the colour black seem to go together.

Black Monday, the stock market crash triggered on 19 October 1987, came a few years before the UK’s exit from the Exchange Rate Mechanism on Black Wednesday. China had its own Black Monday in 2015.

Today, 30 years on, what’s concerning is that there are echoes of 1987 in the current state of financial markets.

Read more: Black Monday: how big was the crash and how fast was the recovery?

Back in October 1987, the Dow Jones Industrial Average plunged 23 per cent, its largest ever one-day drop; the FTSE100 shed 11 per cent; and European markets followed the same downward pattern.

The fall in US markets was twice the size of those during the 1929 market crash (marked by a Black Tuesday and Black Thursday), and greater than any single-day move during the 2008 financial crisis.

The recovery was almost as steep as the precipitous declines. Fears that Black Monday would wreak as much ruin as the 1929 crash, which spurred economic depression, proved overdone.

But there are reminders of Black Monday in the current state of financial markets, and this should worry us.

Back then, valuations had become stretched, as they appear now. The contributing factors were different, of course – the 1987 crash wasn’t preceded by a decade of central banks pumping liquidity to the four corners of the world – but the resulting vulnerabilities are similar.

With stock markets around the world reaching ever-higher all-time highs, markets could arguably be ripe for a rude awakening now.

Black Monday also taught us that markets can become febrile when there’s change at the top of the Federal Reserve, such is the influence of the US central bank.

Back in 1987, investors were unsure what policies new Fed chair Alan Greenspan would adopt. After he stepped in to provide significant liquidity and assurance to halt the crash and limit any economic repercussions, investors assumed he would always do the same.

At the moment, debate is swirling about who might replace Janet Yellen as Fed chair next year.

Whatever the speculation about the Fed’s future actions, this transfer of power is due to take place at a time when US monetary policy is at a very delicate stage and the credibility of central bankers is being questioned on an almost daily basis by the press, investors, and politicians.

Greenspan’s willingness to intervene 30 years ago created complacency among investors that arguably contributed to the 2008 crisis. Central bankers have spent the years since 2008 stepping in wherever and whenever markets have faltered. As a result, financial markets appear to have become sanguine about pretty much any potential shock.

But there are limits to what central banks can control – as they have been quick to point out. The surprise, when it comes, could well unnerve complacent financial markets.

Perhaps most disconcertingly, the 1987 crash happened without an obvious trigger.

The fact that there is no consensus on Black Monday’s cause is what should worry us most, as central banks ever so gently start to peel back the comforting blanket of liquidity that has enveloped financial markets for a decade. Evidence abounds that we are living through febrile times.

The big lesson from 1987 is that we may not be aware of which particular straw will break the back of financial markets until after we have heard the snap.

Read more: Studying the parallels between the property market in 2008 and now

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