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Black Monday: What I Learned from the 1987 Stock Market Crash

Five key lessons from a breathtaking one-day plunge in the Dow Jones industrial average.

Roger Hsu via Wikipedia

A week before the 1987 stock market crash I had all of my investment money in Twentieth Century Ultra, an aggressive stock fund that has since been renamed American Century Ultra (symbol TWCUX). That included money to pay for my stepson’s college starting in less than a year. But I escaped from the ensuing market meltdown unscathed. And I learned some important lessons from the crash and its aftermath.

Quiz: How Well Do You Know Bear Markets?

I started investing in 1982, and for five years, the market did virtually nothing but go up—just as it has for the past 8 ½ years. It was easy for me to put a little money from every paycheck into a mutual fund. But I was a nervous investor so I subscribed to two market timing newsletters and periodically trimmed my stock holdings and then bought back into the market based on the newsletters’ advice. Sometimes the timing calls were good; other times, not so much.

The market gained a stunning 44% in 1987 through August 25 before turning down. Price-earnings ratios were inflated, as they are today. More worrisome, the Federal Reserve had recently pushed the Federal Funds rate up from 6% to 7.25% and the 10-year Treasury yielded 10%, up from 7% at the start of the year. Those rates sound ridiculously high today, but they were commonplace in the late 1970s and the 1980s.

The stock market slide picked up momentum in September. Then on Wednesday, October 14, a report of a larger-than-expected trade deficit for the previous August triggered a record 95-point drop in the Dow Jones industrial average. (Investors worried back then that Japan was gaining economic dominance over the U.S.)

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That night I dialed my telephone hotlines (from a corded phone!), and my newsletters advised selling stocks. Thursday, the Dow lost another 58 points bringing the loss to 12% from the peak, but after the close, I was safely in cash. On Friday, the Dow plummeted 108 points. That was the first time the Dow had ever lost 100 points in a day, and it made for dark headlines in that weekend’s newspapers, terrifying many investors.

I was a Washington reporter covering politics and policy, not finance, back then. But on Black Monday, October 19, I did nothing but stare in horror at the falling stock market on our Associated Press wire service machine. The selloff started in Asia and circled the globe. Volume was so far above past record levels that Wall Street couldn’t keep up. Sell orders often weren’t filled at all or were filled at much-worse prices than investors expected. Many brokers and traders simply stopped answering their telephones—leaving panicked sellers no way out. Remember, individuals couldn’t trade on computers back then.

The crash picked up steam as the day wore on and the panic spread. By the close, the Dow had plunged 508 points—losing an astonishing 22.6% of its value in just one day. The one-day loss was unprecedented, and remains the largest percentage decline to this day. In the 1929 crash, the biggest one-day loss was 13%.

After the October 19 close, many market strategists and economists forecast a deep recession—or even another Great Depression. I feared the worst. I had heard lots of stories about the Depression, and a rerun seemed likely to me.

When I left my office and walked to the Metro station, I was shocked to see that people on the streets and commuters waiting for trains were acting as though it was just another Monday evening. No one seemed unduly worried or upset. Of course, I was. I thought to myself: These people don’t realize yet that the world has just changed dramatically for the worse. The thought gave me goose bumps.

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I was dead wrong. The economy was in good shape and avoided recession. The market finished up for the year in 1987, albeit barely, and a bear market didn’t hit until 1990.

At least part of the blame for the crash belonged to “portfolio insurance”—a badly flawed computer-powered way institutional investors were supposed to be able stem their losses during a sharp selloff. Naturally, portfolio insurance failed utterly just when it was most needed, managing instead to intensify the selloff. Think of portfolio insurance as much the same kind of snafu that caused the May 6, 2010 “flash crash” when many stocks plunged 60% or more for a few seconds, then rebounded.

I spent the next 1 ½ years worrying over my market timing newsletters, which stayed pretty bearish. By the time I got fully back into stocks, I had profited little or nothing over what I would have made had I just stayed fully invested in stocks through the crash.

But I learned some things. Here are my key takeaways from the 1987 crash and its aftermath.

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No one knows what the stock market will do. There is no “smart money” that has a better idea than you or I about which way the market will head next. Be humble about your ability to predict market moves—as well as anyone else’s. I mistakenly thought my market timers had special insight.

The same goes for the economy. Recessions are part of the game. So is inflation. Predictions are guesses, the best ones are, at best, informed guesses.

Expect anything. The stock market could crash today or tomorrow. Something much like what happened on Black Monday will almost certainly occur again. Crashes and cruel bear markets are part of investing. That’s why money you can’t afford to lose, even temporarily, shouldn’t be in the stock market in the first place. I was lucky but foolish with my stepson’s college money.

Never make the kind of big move I did before Black Monday when I sold everything. (Of course, I was young and wasn’t investing all that much.) I talk to investors more often than you’d think who have been out of the market since 2008, and are waiting for another deep bear market to get back into stocks. They’ve passed up huge gains.

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None of this is to say there’s anything wrong with trimming your stock holdings when the outlook for stocks looks dim—or buying more stocks when things look good. But cutting (or raising) your allocation to stocks by more than 10% or 20% will probably turn out to be a mistake. Stocks are still where you’ll likely earn the most money over the long term if you just stay put, as hard as that is to do.

Steven Goldberg is an investment adviser in the Washington, D.C., area.

See also: The Surprising Success of a Dumb Investment