Could the 1987 stock market crash repeat?
Strategist Shane Oliver says it is reasonable to wonder if a re-run of the October 19 crash two decades ago is possible now.
"Black Monday" occurred 20 years ago, the largest single-day stock market decline the world had experienced since World War I. On 19 October, 1987, the Dow Jones Industrial Average fell nearly 25%. With that anniversary looming amid more recent market turmoil, Shane Oliver, head of investment strategy and chief economist at AMP Capital Investors, wonders if thereÆs any risk of a repeat.
ôWhile the anniversary itself has the potential to create jitters, the current situation in share markets is very different to that before the 1987 crash. Share price gains and valuations have been far more reasonable this time around,ö says Sydney-based Oliver.
From mid-1982 to around August 1987, global shares experienced a powerful bull market on the back of recovery from the early 1980s recession, the economic deregulation and reform of the 1980s and a re-rating of shares on the back of the move to lower inflation.
US shares peaked in August 1987. After a gradual drift lower, the US market fell 20% on October 19, 1987 which reverberated around the world. Over the course of October 1987, Hong Kong shares lost 45.8%, Australia 41.8%, and the United Kingdom 26.4%. From their pre-crash highs to late-1987 lows, US shares fell 35%. It took the US share market over two years to rise above its pre-crash highs.
The precise causes of the 1987 crash have been subject to much debate. But Oliver believes the key driver was a combination of a 3% rise in US inflation, a 2 percentage point rise in US bond yields and Fed tightening hitting investor confidence at a time when shares were very overvalued after huge gains and investor confidence was unsustainably high.
[There is another parallel. Today many in the industry blame the risk-management models behind prominent quantitative equity strategies for aligning the whole market into a single trading pattern, which gridlocked when the underpinning assumptions went awry. In 1987, program trading had come into vogue, as had the ill-fated notion of portfolio insurance, which had a similar role in making traders buy and sell stocks according to rules that no longer functioned, but could not adapt in time.]
Oliver points out why the scenario is vastly different now.
Firstly, he says the increase in share prices this time around has been nowhere near comparable to the surge into the 1987 US stock market top.
Second, share market gains this time around have been less than profit growth. Over the four years to the 1987 peak, US share price gains were way in excess of profit growth.
Third, thanks to the strength in earnings growth, valuation measures are far more favourable today.
After rising sharply from their recent lows in August this year, shares are due for a bit of a pull back and weak US economic data may be a trigger, Oliver says.
ôThe anniversary of the 1987 crash is meaningless from a fundamental point of view, but it may create a few jitters,ö Oliver says. ôWhile one can never rule out another crash given the fickleness of investor confidence, the situation today is not comparable to that in 1987. Share price gains have been far more restrained relative to profit growth such that valuations remain reasonable and are a long way away from bubble extremes.ö
ôWhile the anniversary itself has the potential to create jitters, the current situation in share markets is very different to that before the 1987 crash. Share price gains and valuations have been far more reasonable this time around,ö says Sydney-based Oliver.
From mid-1982 to around August 1987, global shares experienced a powerful bull market on the back of recovery from the early 1980s recession, the economic deregulation and reform of the 1980s and a re-rating of shares on the back of the move to lower inflation.
US shares peaked in August 1987. After a gradual drift lower, the US market fell 20% on October 19, 1987 which reverberated around the world. Over the course of October 1987, Hong Kong shares lost 45.8%, Australia 41.8%, and the United Kingdom 26.4%. From their pre-crash highs to late-1987 lows, US shares fell 35%. It took the US share market over two years to rise above its pre-crash highs.
The precise causes of the 1987 crash have been subject to much debate. But Oliver believes the key driver was a combination of a 3% rise in US inflation, a 2 percentage point rise in US bond yields and Fed tightening hitting investor confidence at a time when shares were very overvalued after huge gains and investor confidence was unsustainably high.
[There is another parallel. Today many in the industry blame the risk-management models behind prominent quantitative equity strategies for aligning the whole market into a single trading pattern, which gridlocked when the underpinning assumptions went awry. In 1987, program trading had come into vogue, as had the ill-fated notion of portfolio insurance, which had a similar role in making traders buy and sell stocks according to rules that no longer functioned, but could not adapt in time.]
Oliver points out why the scenario is vastly different now.
Firstly, he says the increase in share prices this time around has been nowhere near comparable to the surge into the 1987 US stock market top.
Second, share market gains this time around have been less than profit growth. Over the four years to the 1987 peak, US share price gains were way in excess of profit growth.
Third, thanks to the strength in earnings growth, valuation measures are far more favourable today.
After rising sharply from their recent lows in August this year, shares are due for a bit of a pull back and weak US economic data may be a trigger, Oliver says.
ôThe anniversary of the 1987 crash is meaningless from a fundamental point of view, but it may create a few jitters,ö Oliver says. ôWhile one can never rule out another crash given the fickleness of investor confidence, the situation today is not comparable to that in 1987. Share price gains have been far more restrained relative to profit growth such that valuations remain reasonable and are a long way away from bubble extremes.ö
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