On Oct. 19, 1987, exactly 25 years ago today, the stock market suffered its worst single-day loss of all time, on what quickly came to be known as Black Monday. The Standard & Poor’s 500 lost 20 percent of its value, by far its largest drop ever. The crash of 1929, the one that kicked off the Great Depression, comes in a distant second at 12.3 percent.
The circumstances leading up to that crash are an artifact of the times, with many conditions that were at their strongest in the 1980s. Investors today are still very wary of the equity markets — witness the more than $60 billion that has flowed out of domestic stock funds this year alone — but we still seem to be a long way from suffering another single-day collapse like that one.
It is a measure of how long ago the whole thing happened to note that the Dow Jones crossed 2000 for the first time on January 8, 1987. The first part of the year was very good for the market, with the Dow rising 44 percent before peaking that August. But there were concerns as well: The Ivan Boesky insider-trading scandal and the troubles encountered by the high-flying investment bank Drexel Burnham Lambert dampened the general public’s confidence in the trustworthiness of the markets.
The macroeconomy was going through some gyrations of its own as the market was rising. Although the legendary inflation of 1979-80 had dropped below 2 percent by much of 1986, it began to turn upward again in 1987, topping 4 percent. Concerned that hyperinflation might be returning, the Federal Reserve quickly raised interest rates, scaring away stock investors and driving long-term bond yields up toward 10 percent, which pushed many investors in the fixed-income market.
What Your Peers Are Reading
And then there was portfolio insurance, now considered a prime factor in the subsequent crash. Many trading firms began to use stock futures as a hedge against precipitous drops in stock prices. But after the Dow peaked in late August and prices dropped over the early autumn, traders found that there were fewer and fewer buyers on the other end of the insurance trades, leading to a massive backlog of sell orders waiting to be fulfilled.
On the week of October 12, the Dow began looking very precarious. On Wednesday the 14th, it suffered a record drop of 95 points; Friday the 16th beat that record, with a drop of 108 points on an all-time high in volume. The index had lost about 10 percent of its value in the course of a single week: about 5 percent of its value over the first four days, then another 5 percent on Friday.
Then there was another shock to the system: war. That Friday, Iranian missiles struck a U.S.-flagged tanker off the coast of Kuwait, and many feared we were headed to an armed conflict with Iran.
On the weekend before the crash, sell orders built up from all that portfolio insurance, as investment managers tried to sell off their futures and cover their insurance. Nervous individual investors also spent the weekend fretting about the market and deciding to get out.