History Doesn’t Repeat Itself But It Does Rhyme
The Disaster of 1929, Black Monday, Fat Finger Error, and now Coronavirus!
October 19, 1987, is referred as the black Monday in the history of world stock exchange market, Dow Jones Industrial Average (DJIA) dropped by 22.6 percent on that day which led the slump of 20 percent by the end of the month in world’s major exchanges. The day particularly sinned as the “Black Monday” as it vanished $ 500 billion from the market and taught the lesson for the future crashes. There have been precautions taken but still many times after that day; we have seen such slumps; the recent ones have been due to Coronavirus outspread.
It Wasn’t A Sudden Disaster
As per an interview given by a Solomon Brother’s veteran to CNBC, there were many reasons behind the market fall which led to Black Monday.
The investors were living in the bear market of 1973 which continued through 1974 and post that, the phase of recovery was quite sluggish. In 1982, the market started breaking out from bear to bull market.
That was the time when portfolio investment became popular. The market was in full “Bull” mood for four and a half year, and thus the fund managers and insurance companies got worried of the repetition of 1930s or 1970s, which further popularized the “Hedge”. According to the agreement signed by institutions for hedging, they were about to make compulsorily short sell if the stock market fall by a certain amount so that they can indemnify the losses of their investors.
On October 13th 1987, Dan Rostenkowski, the then U.S representative from Chicago, and the House Ways and Means Committee passed a trial Takeover Tax Bill in the evening, which restricted takeovers and corporate restructuring, eliminated tax breaks on debt used for mergers and acquisitions which caused investors to reconsider the value of their holdings.
The interest rates were already high for the year and the new Takeover bill added itself. The higher interest rates and the slump in the value of dollar started a storm for an already awaited doom’s day. As a result, on 17th October 1987, the S&P 500 index dropped by 20 percent. This catastrophe led to a panic wave amongst investors and institutions.
And there came the Monday, prices were falling down and as a result of the agreement signed for portfolios and hedge, institutions kept on selling stocks to recover whatever they could. That was the time when investors were not selling to raise money but to save their money.
The “had to sell” agreement further worsened the situation. It also led to mutual fund redemption which amounted a lot in terms of the dollar at that time. It touched the triggered level and individual investors started selling their shares consequently.
That led a perfect storm as arbitrage investors, mutual funds and portfolio investors, all were forced to sell what they could to survive, and these forced selling activities later got marked as Black Monday. From 14th to 19th October 1987, the whole market lost approx $ 1 trillion and was 508 points down.
Market After the Crash
At the end of the October, Dow was 15 percent higher comparing the Black Monday closing points.
The blue-chip index traded between 1,776 and 2,014 points (40 points and 200 points up than the doom’s day) and ended up with a small gain at the end of the year. Dow was still 60 points low at 2,683 compared to 25th August 1987’s measure of 2,746.65. It got the level back in 1989.
The 1929 Disaster
Before 1987, the record for the stock market crash was honoured to the 1929 crisis as it was also preceded by the Great Recession and World War II.
It was latterly a series of black days like black Thursday, black Tuesday, when the Dow fell by 13.5 percent, like 40.6 points. It was 89.2 percent down even in 1932 than the pre-crash level; it took 22 years to climb the 300+ level.
Also, as a result of this crash, the Glass Steagall Act of 1933 was enacted that separated banking activities from investing ones and barred commercial banks to deal in securities.
2010’s Fat Finger Error Flash Crash
After the event of 1987, there have been many flash crashes (flash crash means when the price of a company or a whole market fall drastically for a few minutes and come back to normal).
Like the one on 6th May 2010, when a London based investor Navinder Singh Sarao mistakenly placed the order in billions rather than millions by adding extra zeros and that led to an unexpected crash in Dow.
It was investigated by the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). As per a report by SEC, as a result of this flash crash, 21,000 trades were cancelled as they were traded on a very lower rate; DJAI also lost 998.5 points in just ten minutes. It’s noted that Fat Finger Error is the error caused by entering the wrong value in the mathematical calculation.
Technology Plays a Part to Occur it Again
Can it happen again is an interesting debatable topic. There have been changes but the computer trading which played an important role in the crash of 1987 is still a subtle part of trading.
As per an article by Time, in 2012, in Wall Street, around 75 percent of trading transactions are initiated through computers, and after 8 years now the computer trading picture would definitely be more vivid. Many a time these computerized trading has caused hazardous effects like it made a broker named Knight Capital to go bankrupt in 2012.
Also, such crashes are a result of fear of losing capital which makes investors sell their stocks if the emotional breakdown of fear is stabilized such crashes can be prevented, but it’s obviously a non-occurring hypothetical behaviour of investors, as there will always be overconfident traders powered by new hedging mechanisms.
Circuit Breakers- The Market Saviour
After the crash of 2010, current circuit breakers were put into implementation. According to that, the levels of breakdown have been decided and market-wide circuit breakers react likewise.
Like if S&P 500 index falls down by 7 percent than the previous day’s closing, its level 1, level 2 is set for a drop of 13 percent, and level 3 is a 20 percent drop. In level 1 and 2, the trading session is closed for 15 minutes if it’s before 3:25 pm. If it’s after 3:25 pm than trading session is being continued. In level 3, the rest of the trading session is halted for the entire trading time (9:30 am to 4 pm.)
Before this, DJIA was the benchmark and the levels for circuit breakers were 10%, 20% and 30%. In addition to that SEC has also approved of the “Limit-Up Limit Down” regulation to prevent stocks trading outside a specific range when prices go out of a specific range.
As per Gordon Charlop, a managing director at Rosenblatt Securities in New York said, “How will it pan out and what will be the outcome? That is why they play the game.” Even if such a crash happens again, the circumstances will be different and the consequences will less severe. What goes up faster comes down faster, it may not repeat but it can definitely rhyme.”
After 1987, circuit breakers were rung only once in 1997, but thanks to the widespread of COVID-19, in March this year, the hammer has been hit four times. On March 9, 12, 16 and 18, we witnessed something that had never happened earlier in such a short time span.
Though, the situation is different now, we are noticing the market going upwards even when the number of deaths because of Coronavirus in the US, as well as worldwide, is hiking. It is another equation to be narrated, but wait till the next time!
