No recession, lower interest rates and stock discounts
Tim Duy was a freshman in an introductory course in economics at the University of Puget Sound. Jon Wolf had just broken loose from a big investment firm to join an upstart, independent firm in Anchorage, Alaska. Dean Dordevic was in asset management with Kidder Peabody on Wall Street.
“I was in that office that day,” Dordevic said. “What really happened was there was a mechanism in place where selling begat selling and it just cascaded on itself. The rest is history.”
Steve Lelli, at the time an investment adviser in Bend, remembered it, too: “It was an ugly day from the start. There was a lot of red on the screen.”
That day was Oct. 19, 1987: Black Monday, when stock markets experienced their greatest one-day fall in history. The Dow Jones industrial average lost 23 percent of its value that day; the Standard & Poor’s 500 index lost more than 20 percent. Back then, the Dow closed at 1,738, a fraction of its value today.
Thirty years after the crash, the Dow and the S&P are both in record territory. The Dow on Wednesday closed at 23,157; the S&P closed at 2,561.
A number of factors, most of them associated with an increasingly complex stock market, created Black Monday. Often-cited causes are portfolio insurance, a product meant to mitigate losses in stock trades but that triggered further stock sales as prices fell, which triggered computer programs that triggered further automatic selling, which triggered further selling in large volumes.
That’s one simple explanation of a complex event.
Experts agree that Black Monday illustrated that the stock market, because of technology and changing investment strategy, had changed permanently. They also agree that Black Monday presented an opportunity to create wealth.
“There was opportunity. Stocks we may have bought three or six months earlier were on sale at 20 percent off,” said Lelli, now Bend branch manager for D.A. Davidson, a Great Falls, Montana, investment firm. “We were quite busy.”
Dordevic, now a principal at Ferguson Wellman Capital Management, a Portland firm with clients in Bend, said one veteran trader saw the upside right away.
“Our head trader, when the market was down almost at the bottom for the day, turned to me and said, ‘I wish I had a million bucks right now,’” Dordevic said. “A lot of gray-haired people at the time thought Monday was a good day.”
Prior to the 1980s, traders worked the fundamentals, didn’t expect huge returns and when the market surged, considered it a temporary phenomenon, said Wolf and Dordevic.
“The market really peaked in the late ’60s and didn’t go anywhere for 15 years,” Dordevic said. “It never really penetrated that level until August of ’83, and when the market definitely went through 1,000, nobody believed it. It was always based on the notion that gains were fleeting, that it would go back to where it was.”
Wolf, today an economics instructor at Central Oregon Community College, said he and his partners had just set up shop and had cash at hand. The senior partner, a contrarian broker, looked for opportunities where others feared to tread, like investing in the Mexican telephone company in the aftermath of an earthquake, Wolf said.
“He was brilliant in finding these crazy, contrarian opportunities, and our clients loved us,” he said. “We basically preached huge risk.”
At the time, the market was starting to embrace technical investing. Rather than studying financial statements to calculate stock price, technical traders studied stock price fluctuations, Wolf said.
“You use econometric data to determine trends, and make an assumption that Wall Street is highly randomized, and if you can find a pattern, you make money,” he said. “Black Monday was really the first indicator that the market itself was a commodity.”
Unlike the comparatively slow-motion drop in market value starting in 2007 that preceded the Great Recession, Black Monday spawned no longterm economic downturn, although two years passed before the stock market regained the value it lost that day. The Federal Reserve cut interest rates that allowed the financial sector to regain its footing, said Duy, now an economics professor at the University of Oregon. That brought some liquidity back into the financial system.
“Think of it this way: When your house falls in value, you can’t borrow against it for as much money. But lowering interest rates recoups some of that borrowing capacity,” he said.
Interest rates then were higher than today. The federal funds rate, the interest charged by banks lending to other banks overnight, on Nov. 1, 1987, was 6.69 percent. That rate today is 1.25 percent.
Back then, with higher interest rates, the Federal Reserve had room to maneuver and forestall a recessionary slide. It has room now, but not as much, Duy said.
The record-setting heights reached by the Dow and S&P so close to the anniversary of Black Monday for some summons its ghost. The lesson, said Wolf, Dordevic and Lelli, is to accept only as much risk as your financial goals can accommodate.
“You have to be engaged and you have to play or you don’t make any money. Sitting on the sidelines doesn’t work,” Wolf said. “The next piece of that question is: What are your goals? Match your risk to your goals.”
None would say a precipitous loss of one-fifth of market value can never happen again, even though Wall Street has since implemented measures to stop cascading computerized trading. Duy said he doesn’t delve into the causes and consequences of Black Monday in class, except briefly for its lessons on monetary policy.
“It’s ancient history, man,” he said.
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