Before the global financial crisis the yardstick for market panics was 19 October 1987: Black Monday. Shares across the world tanked, led by an eye-watering 23 per cent fall on the totemic Dow Jones Industrial Average in New York – the worst one-day decline since the start of World War One.
Meanwhile, the FTSE 100 fell 11 per cent on the day, and then fell a further 12 per cent on the next, wiping out more than a fifth of the value of the UK stock market in just two trading sessions.
What caused it?
What is perhaps most terrifying about Black Monday is that nobody truly knows what caused it, despite a deluge of academic studies and regulatory inquiries in its aftermath.
At the start of 1987 the Dow Jones Industrial Average had enjoyed its biggest one-day point rise, shortly after breaking 2,000 points for the first time, but by October concerns about the global economy had been compounded by sabre-rattling in Iran.
War and weakening economic fundamentals are classic drivers of stock market sell-offs, but it is impossible to understand Black Monday without reference to the new technologies which had upended markets in the previous decade.
A key factor blamed for the depth of the rout was the new fad for portfolio insurance. Algorithmic trading programmes were set up to protect against losses by short selling index futures. While in theory this is a sensible hedge, on Black Monday the effects were brutal, with computer traders piling extra weight on a market already flying downwards.
“Black Monday was a watershed moment,” says David Parker, UK banking lead at consultants Accenture. “It was the first time we saw the seismic impact of technology failing to cope with unexpected circumstances.”
How did things change?
The global financial crisis was world-altering – as is still becoming more evident a decade after its first ructions; by contrast Black Monday’s repercussions were strongly felt, but the crash did not lead to the tortuous recessions through which Western economies have struggled since 2007.
Indeed, investors’ recovery from Black Monday was much quicker, with the Dow Jones regaining its losses by January 1989.
In the UK markets as measured by the FTSE All-Share index had completely recovered within five years, according to Hargreaves Lansdown.
“Looking back on the 1987 crash today, anyone who wasn’t there might wonder what all the fuss was about,” says Tom Stevenson, investment director for personal investing at Fidelity International. The shattering event seems “no more than a stumble in the market’s relentless long-term rise”.
A decade after the crash Federal Reserve Board governor Susan Phillips hailed markets’ stronger ability to “absorb market shocks”, with improvements in trading houses’ abilities to handle big surges of activity, the capitalisation of market makers.
A decade after that stock markets crashed once again. The more things change, the more they stay the same in financial markets.
So are we in for a repeat?
Bubbling equity valuations which barely reflect companies’ underlying performances; rising interest rates; geopolitical tensions: stock market doom-mongers are currently enjoying a roaring tradeas the similarities to conditions in 1987 pile up.
Meanwhile, some investors are expressing rising fears that portfolio insurance-style strategies may be quietly building up as trend-following investment programmes again accumulate money.
Yet a repeat of Black Monday in the strict sense is unlikely, says Accenture’s Parker: “The specifics of Black Monday have long been addressed and stress tests now exist as the anchor for managing risk.”
And even if monetary policy from major central banks is likely only going to tighten in the next few years, a rate shock is unlikely, given the broad accommodation still in place.
Kit Juckes, global fixed income strategist at Societe Generale, says: “Monetary policy settings and the level of bond yields are at levels that suggest the market souffle can rise a fair bit more before the inevitable happens.”
Chances of a bear market, in which prices drop by more than 20 per cent over two months, are limited for now by the strong US economy, according to John Higgins, chief markets economist at Capital Economics, although a smaller correction is likely if US tax cuts are not passed.
However, others are less convinced. Equity valuations remain “rich”, according to Nick Dixon, investment director at pension fund behemoth Aegon, which has recently reduced its exposure to frothy US equities and British property, as well as raising its protective cash levels.
“While we do not expect dramatic falls of the nature we saw 30 years ago, elevated valuations have shifted the market environment considerably in recent months,” he says. “Now is therefore the time to take a more cautious and circumspect approach.”