BLACK MONDAY – OCTOBER 19, 1987

The worst day in market history was October 19, 1987 – 35 years ago tomorrow. Some analysts will mention this on market news, perhaps referring to “old timers” who remember Black Monday.  To me, it seems like only yesterday. It was the most fearful day I have experienced in my 53 years of investing.

PERSPECTIVE

This year has been difficult for investors. Stocks have declined 20%. More dramatically, bonds have declined too. Stock declines like this occur every few years. But for the last 40 years bonds have had steadily falling interest rates. The 30-year treasury bond yielded 14.5% in 1981 and 1.3% in 2020. (Bond prices increase as interest rates drop.) As rates have risen this year, bonds have dropped 16%. 2022 could end as only the third year in a century that stocks and bonds both declined.

It is important to keep these events in perspective. First the bond market. America cannot continue to borrow and run government deficits without serious negative consequences. Nothing lasts forever, and interest rates had to increase eventually. And “eventually” has arrived. Investors can be forgiven for taking low interest rates for granted.  You must be 60 years old to have been an adult when interest rates last rose significantly.

THE ‘MOTHER’ OF ALL MARKET DROPS

People always think that the current bad market is the worst ever. Historical perspective is important. And unfortunately, we get more perspective from experience than from reading history. You just had to be there!

The 1987 crash ended a five-year ‘bull' market. The Dow Jones Industrial Average rose from 776 in August 1982 to 2,722 in August 1987." Then, in 8 weeks, the Dow declined 17%. On October 19, forever known as "Black Monday," the Dow plummeted another 23%, the greatest loss Wall Street had ever suffered in a single day. (An equivalent one day drop now would be about 7,000. That would get your attention!)

I was working in New York at the investment firm, Reich & Tang, very aware of the disaster that was occurring 3 miles south at Broad & Wall Streets. Our office was eerily quiet. About 4:30, a lady who worked in the next office came to my door, and in hushed tones, said, “The Dow is down 508 points.”  The worst day ever!

We had no idea whether the market and the economy would now freefall as they had in 1929.  Everyone was scared. After work, I walked up 5th Avenue toward our apartment. My world had just collapsed. Reich & Tang might go out of business. 

When I got home, Sammi and John McPherson, who had come up from Winston-Salem, were waiting with my wife Judy.  We were going to dinner and the theater. John recalls that I was pale when I walked in. My remedy for crises has always been – eat something. And John remembers that I ate a one-pound can of Planters’ peanuts while we visited.[i] 

BEING ‘CONTRARIAN’ HAS ITS CONSEQUENCES

Tom Quinn, the chief investment officer at RJR Investment Management in Winston-Salem was buying stocks like crazy that afternoon.  And when the rest of the world, or 99% of it, was either selling or frozen with fear. The consequences of his decision, a courageous and correct one, show how hard it is to be a contrarian who does the right thing. He later recalled:

I could have been characterized as dangerously unemotional. We were buying stocks for a new $100 million portfolio. By October 18, we had purchased $60 million of stocks, and we held $40 million in cash, planning to be fully invested by month-end. On October 19, we watched the market crash that morning.  We were experiencing pure panic in the market. This was most likely an excellent buying opportunity.  That afternoon, with the market down over 20%, we completed the buying.

This decision was logical and economically correct.  But I was threatened with termination because of this economic wisdom.  Black Swan [unexpected] events create unique opportunities to make money.  However, emotions that create the event will also constrain people from capitalizing on that event.

Some called my not getting caught up in the emotions of the day a "Herculean effort".  It did not seem Herculean to me, just simple investment common sense.  But what I did may have been more stupid than stupendous. It almost cost me my job.

On the day following the crash, the CEO, expressed shocked that we were buying stocks when the market was crashing.  He wanted us to move the pension fund to 100% cash.  We argued that such action was inappropriate.  We held a series of meetings and discussions to resolve our major differences and reached a compromise. Our investment group agreed to hedge (short) 20% of the plan assets, $370 million. [If the market continued to decline, the trade would profit. If the market advanced, the trade would lose.]

We took the short position 30 days after the crash. Ironically, that was the day the market bottomed. My theory has always been that it took 30 days for the last ERISA fiduciaries to argue, resolve their differences, and complete their liquidation of plan assets. 

Now, being a little wiser, I realize that making the most money at the lowest risk is not the primary objective of fiduciaries or their agents (advisors).  The primary objective is to cover your backside and keep your job or investment account.  It is a matter of short-term thinking rather than long term investing.

The 20% shorting of the S&P 500 Index resulted in a significant loss for the pension fund. A year later, CEO Ross Johnson put RJR ‘in play’ as a buyout.  Floyd Rodgers, a Winston-Salem Journal reporter, interviewed Johnson.  Floyd asked about the shorting incident. Ross dismissed the question, saying, "We made money on that move." In this business, lots of people make terrible decisions and later claim they are not!  His comment still infuriates me.[ii]

WHAT CAUSED THE CRASH?

No single factor was ever identified as the cause of the crash. The ‘usual suspects’ included computer trading, illiquidity, U.S. trade and budget deficits, rising interest rates, and overvaluation. My favorite culprit was ‘portfolio insurance’ – a bizarre scheme dreamed up by academics - a subject for another post, in depth.

AFTERMATH

Aside from some over-leveraged brokerage firm failures, nothing much happened afterward.  The market recovered in a few months, and the economy never lost a beat.  The damage was limited to Wall Street; it never touched Main Street.[iii]

LESSONS LEARNED

If there is a lesson in this, it is that markets do unexpected things. The market should statistically never have had a day like this, but it did.  I am amused when people talk about a current ‘devastating decline.’  They have forgotten, if they've been around long enough to even know, that the market is a risky place. 

Statistically, market movements are not a normal distribution. The probability curve has “fat tails.  Bad market events that should happen only about once every 30 years really occur about every 20 months. If you cannot stand the shock, you do not belong in the market. If you don’t know who you are, the market is an expensive place to find out!

[i] We saw a revival of Anything Goes, a musical comedy from the 1930s.  A line in the play about the stock market crash in 1929 brought nervous laughs from an audience that couldn’t quite get the day off its mind. The McPhersons’ friend, Bill McCutcheon, won a Tony [Link] for his role, Moonface Martin – Public Enemy #1. Bill, a delightful man, was Uncle Wally on Sesame Street and a chairman of the board in the movie Mr. Destiny, filmed in Winston-Salem in 1989.

[ii] After the hedge, the market increased 14% in the next 6 months and 40% in 18 months. We don’t know when RJR covered its hedge position, but it probably lost between $50-$100 million on the trade - stemming from an emotional and rash management decision, so characteristic of Ross Johnson’s style. Tom Quinn had followed to the letter Warren Buffett’s instruction, “Be greedy when others are fearful.” Tom was ‘greedy’ at the very moment when the market was experiencing the most fear it had ever had. Yet his courage to do this nearly got him fired. In the investment business, being right when nearly all others are wrong is not for the faint of heart.

[iii] Even the ‘experts’ had become paranoid. Shortly after the crash, a Reich & Tang portfolio manager attended a lunch for the NY Security Analysts.  The speaker was a renowned hedge fund manager and pundit. He said that the entire market was a “short.” When asked for specifics, he said, “You guys. Your businesses are going broke.” Ironically, few better opportunities ever existed to invest in the investment advisory business. This speaker is still revered on Wall Street for his ‘expertise.’