10 lessons from the market crash of 1987
The more things change, the more they stay the same — except computers are faster
October 1929. THE stock market crash. Highly leveraged investors
saw fortunes melt in minutes as the roaring 20s gave way to the Great
Depression. The crash of October 1987 conjured fears of another Great
Depression, but instead stocks recovered.
Even though market
controls, such as circuit breakers introduced after the “flash crash” of May 6,
2010, are designed to avoid another crash like Black Monday, markets are still
susceptible to severe and prolonged downturns.
With that in mind,
MarketWatch polled several money managers who witnessed Black Monday about
lessons from 1987 that are relevant to investors today.
1. Stay objective when others get
emotional
In order to keep cool
when the rest of the world is falling apart, investors need to have confidence
in their portfolio choices, because success depends on surviving the market’s
worst, said Peter Langerman, president and CEO of Franklin Templeton’s Mutual
Series funds.
Langerman, who started
with Heine Securities Corp., the predecessor to Franklin Mutual Advisers, in
1986, said today’s high-frequency trading algorithms are not too different from
the herd mentality that spooked investors on Oct. 19, 1987. “One of the basic messages is you’re never
going to be right all the time and things can go wrong, so you have to have the
confidence that your investment portfolio can stay intact to sustain yourself
through illogical times,” Langerman said.
2. Be like Buffett: Buy on the
fear, sell on the greed
While Black Monday made it into the
record books, crashes are fairly common throughout history, said Charles
Rotblut, vice president at the American Association of Individual Investors. See slideshow of the 10
greatest market crashes. “One of the big things
you realize is that if you just stick with the long-term portfolio you’ll be
okay,” Rotblut said, noting that after 1987, large-cap stock prices rose about
12% in 1988, and about 27% in 1989.
Investors who used the
crash as a buying opportunity took full advantage of those recoveries, Rotblut
said.
3. Make a crash shopping list
To take advantage of
bargains in a downturn, don’t wait until the market tanks to decide what you
want. Make a list of
companies you’d like to own if they weren’t so expensive, said Marty Leclerc,
principal at Barrack Yard Advisors, who was a young branch manager at brokerage
Dean Witter 25 years ago.
“Use that extreme volatility to your
advantage,” Leclerc said. He mentioned Nike Inc.NKE -1.15% as a prime example. In the two
trading sessions on Oct. 19 and Oct. 20, 1987, Nike shares fell to 94 cents
from $1.27, a total decline of 26%. The stock recovered to pre-crash levels by
late January 1988, and 25 years later trades at close to $100 a share.
Stocks on Leclerc’s
shopping list nowadays include financial exchange operators and global
agriculture proxies ranging from fertilizer makers to bioseed companies.
4. What goes up fast comes down
faster
“Any kind of model that
purports to make a lot of money in stocks is doomed to failure,” said economist
Gary Shilling, president of A. Gary Shilling & Co.
The crash of 1987 was a
big one-day correction to a stock market that had spent the first half of the
year gaining momentum, Shilling said.As many of the managers
interviewed noted, one of the big causes of the crash was a strategy called
“portfolio insurance,” which was designed to limit losses by buying stock index
futures in a rising market and selling them in a declining market.The problem with such schemes,
Shilling explained, is that when they become widespread, they no longer reflect
the fundamentals upon which they were first modeled. When plugged into
programmed trades, the compromised system is overwhelmed and prone to crash
5. There’s no such thing as ‘it
can't happen’
One statistician told
Ted Aronson, who founded institutional investment firm AJO in 1984, that the
1987 crash was a 25-sigma event, or 25 standard deviations away from the mean.
In other words, a virtually impossible occurrence.
The problem with this thinking is
that the virtually impossible happens all the time. See Mark Hulbert's column on
the inevitability of another crash.
“We think as humans, we
identify patterns and trends when there’s a whole craziness going on in the
market that’s more akin to ‘The Twilight Zone,’” Aronson said.The best advice Aronson
has for investors is to not get lost in fads, keep costs down, and diversify
assets.
6. Tune out the daily noise
Corrections of 10% are
common and typically happen about three times a year, said Bob Pavlik, chief
market strategist at Banyan Partners.
Pavlik, who started as an assistant
portfolio manager with Laidlaw, Adams and Peck in 1987, said he does not think
shareholders have learned many lessons in the past 25 years. Investors still
panic during corrections and forget that they are part of the market’s ongoing
contraction and expansion cycle. Read more: Jack Bogle: Forget
trading; start investing. “If you focus on the
details, you can lose out on the big picture,” Pavlik said. Then, he added,
“you lose out on those cycles that will help you,”.
7. Don’t bail
After Black Monday, an
army of economists warned that the financial world was coming to an end, said
William Braman, Chief investment Officer at Ballentine Partners. Investors who
believed them missed out.
Braman, who was focused
on large-cap domestic growth portfolios at Baring Asset management in 1987,
said investors need to position their portfolios to shoulder daily and weekly
volatility.“You’ve got to stay
focused long-term and not get wigged out by the short-term noise,” Braman said.
Roy Diliberto, who
founded RTD Financial Advisors in 1983, echoed the sentiment.“The problem with
bailing out is you never know when to get back in,” Diliberto said.
8. Don’t use the calendar to
rebalance your portfolio
If you rebalance your portfolio
quarterly or annually, shedding winners and scooping up losers, you may want to
rethink that practice.Diliberto said improved portfolio
management software allows investors to rebalance their portfolios in
accordance to market events, or what he calls “opportunistic rebalancing.” “In 2009, we were overweight in
bonds and went into asset classes that we were underweight in, and we got to
break-even before people who had just stayed the course,” he said.
9. Bet with your head, not over
it
Margin calls fueled the fire in
October 1987, according to managers who lived through the crash.
And even though margin
requirements have been tightened since, individual investors should avoid it,
said AAII’s Rotblut.The only margin call the individual
investor should care about is an opportunistic one — such as when hedge funds
have to sell on the cheap to cover their bets, putting downward pressure on
prices and creating bargains, Barrack’s Leclerc said.
10. Investors face greater risk
now
In 1987, portfolio insurance and
program trading threatened the orderly functioning of the financial markets.
Today, high-frequency trading algorithms move massive volume in microseconds
and amp up volatility.That sort of risk, as evidenced in
market gyrations since 2000, has damaged retail investors’ appetite for stocks,
according to Jeff Applegate, chief investment officer of Morgan Stanley Wealth
Management.Also, the rise of technology and
widespread online trading has made individual investors more vulnerable to
knee-jerk trades, without the benefit of a broker or pension plan manager
talking them off the ledge, Rotblut said.But as technology makes it easier
for investors to go it alone without traditional guidance, volatility can
create anxiety and make investors vulnerable to fads and higher fees.
“Investors are more exposed to
risk now,” said AJO’s Aronson. “There are more opportunities to lever
investment ideas, to amplify investment ideas, and more ‘advances’ that have
given investors more opportunities to pick their own pockets.”
What do you
think? Do you expect another crash like 1987’s? Make yourself heard:Click here to take our poll :
Wallace Witkowski is a
MarketWatch news editor in San
Francisco
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