Ten Years After the Stock Markets Collapsed
Black Monday Revisited
On Monday Oct. 19, 1987—a decade ago this weekend—stunned stock traders and brokers sat at their computer screens watching the market tumble in an unprecedented free-fall. What happened and why?
On Friday Oct. 17, 1997 G. William Schwert, a contributor to the New York Stock Exchange’s report on Black Monday, joined us for a chat to answer some of those questions. He is currently a professor of finance and statistics at the University of Rochester’s William E. Simon Graduate School of Business Administration.
Moderator at 2:05pm ET
Hello and welcome to ABCNEWS.com's chat about the crash of october 19, 1987 and what it means today. Our guest today is G.William Schwert, professor of business administration, finance and statistics at the University of Rochester.
Holly from [199.20.97.2] at 2:06pm ET
Why did the market crash like it did?
Professor G. William Schwert at 2:06pm ET
That's a good question, Holly. If I knew the answer to it, they'd have me up for the Nobel Prize instead of Professors Merton and Scholes. Less humorously, I think what people agree on is that there was a lot less liquidity in stock markets around the world than people had thought there was, so that when people all tried to sell at the same time, prices fell much faster than expected. That, of course, begs the question about why they fell.
Johnny E. Devould from [129.188.33.203], at 2:07pm ET
Is there anything in particular about the month of October that affects the stock market? It appears, the last major crash also happened in October of 1929.
Professor G. William Schwert at 2:08pm ET
Interestingly enough, if you looked at the data for the US STock market back into the 19th century, you'd find several other big crashes in October. That's a lot more understandable in the 19th-century US - it was a much more agricultural economy, with less sophisticated banking and money mechanisms than today or even in 1929. I think the fact that you've seen crashes in October of 1987 and even a small one-day blip in October 1989 is merely coincidence.
Rick from [207.100.205.139] at 2:11pm ET
How did the P/Es in 87 compare to those in 97?
What safeguards have been put in by the exchanges to prevent computer generated sell orders from causing a crash on what should be a much smaller adjustment?
Professor G. William Schwert at 2:11pm ET
PE's (price-earnings ratios) on the Standard & Poor's COomposite Portfolio, which is the measure people traditionally use, had reached levels of about 22 at the end of September 1987, and of course when prices fell and earnings didn't fall anywhere near that much, PE's fell back down into the ratio of about 15. But as early as January 1992, the PE ratio on the S&P Index was up above 22 - it was actually over 23 - and it's been generally in the range of 16 - 23 since then. The most recent data I've got shows it being around 20 in April, which means it's probably a little higher than that now. The point is that PE ratios since the beginning of 1992 have been at levels not too dissimilar to right before the 1987 crash, and we haven't had a crash since then, so I'm not too worried about it.
Professor G. William Schwert at 2:16pm ET
In the early 1990's, they put into play a whole collection of calculations that affect trading halts and the linkages between trading on the New York Stock Exchange and, for example, the futures markets. They were recommendations made by, among others, the Brady Commission, that recommended that trading be halted when there were big changes in prices. Rules called circuit-breakers were supposed to be triggered when there was a 250-point drop (for a one-hour halt) or a 400-point drop (for a two-hour halt) in the Dow Jones average in a day, although those have never been triggered. They were just revised earlier this year upward to threshholds of 350 points and 550 points, but an interesting sidelight is that those are absolute changes in the index, and they don't take account of the fact that the level of the index has grown dramatically since the rules were first put in place. So in percentage terms, the triggers are much more sensitive now and much more likely to be put in place. There are also rules that limit traders' ability to trade baskets of stock on the NYSE using computers, when the Dow Jones average is moved 50 or 100 points in a day. Those rules haven't been changed at all since they were implemented in 1990, and as a result they've been triggered many times in 1997. I don't think that actually has much to do with a crash - I think it actually affects making the business of trading stocks more difficult.
Tim Hanson from [207.38.87.5], at 2:17pm ET
Although the market had the biggest drop in 1987, wasn't the drop smaller as a percentage, than had occured during the great depression?
Professor G. William Schwert at 2:20pm ET
No, Tim, your intuition is right about everything except October 19, 1987. On that date the Dow and the S&P indexes both dropped more than 20% in one day. The biggest drop in the Depression was 13% on October 28, followed by 12% on October 29, 1929. Now if you combine those two drops, it's bigger in 1929, but the biggest one-day drop was October 19, 1987. I think the bigger point you may be trying to get at is that we've had lots of big absolute changes in the Dow Jones index in the last year and a half, in fact, 22 out of 25 of the biggest increases have happened since January 1996, and 17 of the 25 biggest drops, and yet in percentage terms, none of those changes has been particularly large in historical terms. None of them made the list of the top 25 percentage changes in the Dow Jones index. This tendency to focus on absolute changes in the Dow Jones index causes people to think markets are more volatile than they really are.
Asif Patel from iss.umist.ac.uk at 2:20pm ET
To what extent will the expectations of a stock market crash cause one to actually occur ?
Professor G. William Schwert at 2:24pm ET
That's an interesting question. I think as a theoretical possibility, it's something economists and journalists enjoy writing about. The difficulty is that if the expectations of the crash are unfounded by underlying phenomena, like what's going on in the real ecomony, then a crash or a big drop in stock prices would generate large returns for people who didn't join the crowd and sell stocks. So my personal belief is that the ability of people who look at fundamentals and conclude there's no justification for stock prices to be dropping as much as they are will provide a counter-balance to the people who believe a crash is coming. Having said that, one of the things the circuit-breakers and trading halts I mentioned earlier can do, and it's not a implausibility, is create a situation where everyone in the market knows that a trading halt is about to be triggered if prices drop a little bit more and are anxious to trade, the threat of a halt will cause them to sell at prices they ordinarily wouldn't have considered, and that will actually speed up the halt. It's a little like yelling "FIRE" in a crowded theater, eveyrone will rush out very quickly even if there isn't a fire, because if there actually is a fire, the cost of remaining inside will be very high. But again, none of those halts has been triggered yet, so we don't actually know.
DOREEN from [38.221.199.10] at 2:25pm ET
CAN BLACK MONDAY HAPPEN AGAIN ANYTIME IN THE NEXT TWO YEARS?
Professor G. William Schwert at 2:26pm ET
That's the $24,000 question. Of course it can happen again, but I think it's highly unlikely. The October 19, 1987 day is the single largest percentage change in market indices in approximately 31,000 days of trading data we have in the US, spanning periods of world wars, dropping nuclear bombs, collapses of major financial instutions, all sorts of very dramatic ecomonic and political events that you'd think might affect stock prices. In some ways, the biggest puzzle about October 19, 1987 is that there wasn't one of these major events. So it could happen - but the odds are certainly against it.
Jim Diver from concentric.net at 2:27pm ET
What should stock holders do in the event of a market crash? Remain cool or join in the panic??
Professor G. William Schwert at 2:30pm ET
The best thing to do is what most people did in 1987, which is nothing. I think one of the things we learn from the numerous studies that were done on that crash is that there were a number of institutional investors who liquidated stocks fearing the holders of those mutual funds would want to liquidate, who a week later discovered that they were sitting on a pile of cash and there had not been massive redemptions of mutual funds shares. While there was a lot of trading volume on October 19, 1987, even if the turnover was 3%, that means 97% weren't sold. The right way to think about it for individual investors is not to think about day-to-day movements of the market as things that should make you buy or sell. There's not much evidence, including October of 1987, that there's any persistence in the way prices move. One of the biggest up days in stock market history actually happened right after the October 19, 1987 crash - October 21, 1987 the Dow Jones rose about 10%, so anyone who sold on October 19 or 20 missed that rebound. Not that you should expect to rebound either - on October 27, they fell again, so what you were seeing was a period of high volatility, moving up and down by large amounts but not in a predictable way. So the short answer is, sit tight.
Grayson from [204.30.72.135], at 2:14pm ET
Are yesterday's and today's 100+ point declines on the Dow related to the aniversary? Or was there some other news casting a shadow on the market?
Professor G. William Schwert at 2:32pm ET
Grayson, one of the things I've learned through my many years as an academic student of, and participant in, financial markets is not to try to diagnose day-to-day movements too much. There have been lots of 100-point days up and down in the last few years, which reflect movements of a little more than 1% of the market up or down. A 1% move in the stock market is not unusual by historical standards. A lot of what you're seeing is a reflection of the fact that the level of the index is high, so a 1% move seems large. Having said that, all the press attention on the anniversary of the crash is probably heightening people's awareness, but it's hard to imagine that's affecting prices much.
Weldon from [207.205.79.61], at 2:35pm ET
Do you not feel that legislation passed earlier in the week making it somewhat harder to complete LBO's contributed to the major sell off on Black Monday, which actually started on Friday with a 109 point fall?
Professor G. William Schwert at 2:35pm ET
While it's an interesting theory that that may have been one of the triggering mechanisms for the 1987 crash, that legislation (which was tax legislation) did not actually pass. It was debated and introduced into Congress in the middle of the week, a couple of days before stock prices began dropping. One of the things about the 1987 crash that is hard to explain relating to that US tax legislation is that the crash was not a US phenomenon - it affected markets around the world.
Leonard Brown from jeffherr at 2:36pm ET
Hello professor. But can safeguards actually influence what some see as the core cause--human's nature to panic combined with short-term investment behavior?
Professor G. William Schwert at 2:38pm ET
Leonard, that is certainly the rationale that the proponents of circuit-breakers have put forward on their behalf. The other side of the coin is that if you look at traders in financial markets around the world, every day they are faced with having to deal with uncertainty and the risk of price changes, and there's no real evidence of overreaction on a systematic basis, that is, prices falling and then rebounding in a predictable way. That's what you'd expect if people had this innate tendency to panic and overreact - prices would fall too far and then come back up, or rise too fast and then come back down. That would give people who don't panic the opportunity to jump in and take advantage of the people who do. It's really a question of whether overreaction is a common phenomenon, and I don't think the evidence shows that it is.
Moderator at 2:39pm ET
Thank you Professor Schwert for joining us today. Thank you also to all our users for your questions.
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