Wall Street has no shortage of market crashes, but one of the biggest collapses ever occurred Oct. 19, 1987 - a day known as "Black Monday," when the Dow Jones Industrial Average lost 509 points in a single trading session.
The decline in the stock market resulting from Black Monday in 1987 amounted to 22.6% of the entire Dow. That was the largest single trading session decline in U.S. history - even more than Black Monday in 1929, which resulted in a 13% market fall.
The market rebounded faster after the 1987 crash than it did in 1929, when the Dow took two decades to fully recover. After 1987, stocks took two years to top the levels seen Oct. 16, 1987 - the last trading session before Black Monday.
That doesn't mean the fallout from the stock market crash of Oct. 19, 1987 wasn't serious and didn't have ripple effects - it did. For example, the market collapse fueled major losses in worldwide exchanges, with many declining by 20% in the days following Black Monday.
Leading Up to Black Monday
Unlike the stock market crash of 1929, which had no shortage of major warning signs that disaster was imminent, the red flags pointing to the 1987 market downturn weren't so obvious.
Burgeoning trade deficit issues (which continue to be a priority for U.S. political leaders today) were perhaps the biggest warning sign that the financial markets were at risk. Efforts to limit trade advantages by Asian countries stoked controversy, as larger investors worried that Pacific Rim countries would respond to anti-trade policies by shunning U.S. government bonds.
Other factors came into play, too, in advance of Black Monday.
The U.S. government, via the Securities and Exchange Commission, pointed directly to a bill passed by the U.S. House of Representatives on Oct. 15, four days before Black Monday, that eliminated government-funded corporate takeovers (the thinking in Congress was that Uncle Sam shouldn't be in the business of helping companies swallow up other companies via takeovers.)
Given a serious military conflict between Iran and Kuwait, which drew immediate intervention from the U.S. and insider trading scandals on Wall Street that spread investor distrust, the corporate takeover bill fueled speculation that corporate profits could dry up.
All of the above factors fueled an imbalance of sellers over buyers in the days before Black Monday.
What Happened on Black Monday?
The stock market crash of 1987 caused significant damage, with the Dow losing 22% of its value. There are multiple reasons for the crash itself, with several key triggers contributing to the carnage on Black Monday.
These headliners are at the top of the list:
- A declining dollar. In the weeks leading up to the Black Monday crash of 1987, the federal government released news of a widening trade deficit, which roiled financial markets and weakened the U.S. dollar. A weaker dollar, in turn, triggered a run away from dollar-denominated assets, hiking interest rates in the process. The news by itself wasn't huge, but it was enough to get the ball rolling as sellers stormed the stock market looking to unload shares on Friday, Oct. 16 (the Dow was down 4.6% for the day - a precursor to the larger decline on Black Monday.)
- Widespread media coverage. Nobody is blaming the media directly for the Black Monday stock market crash. The fact is, however, the 1987 crash was the first time that television viewers around the world could see a market crash in real time, as viewers watched the collapse unfold on CNN and on the local news. That was a big deal back in 1987. The visual images of traders in agony on global trading floors proved immense and the response was predictable. The more average investors watched the news on Black Monday, the more they wanted to sell out of their portfolio positions.
- Portfolio insurance. Critics also pointed at portfolio insurance as a cause of the Black Monday stock market crash of 1987. This type of investment vehicle involved the trading of risky derivatives and options, which led to further declines in the market. Basically, traders used portfolio insurance as a hedging tool, deploying stock index futures to insulate stock portfolios against massive market declines. The trading of risky securities became such a threat to market stability that stock market regulators implemented so-called "circuit breakers" that could stop stock market trading when exchanges experienced extreme volatility and large losses.
- Digital trading. Another target of criticism was computerized trading, more formally known as "program trading" by Wall Street insiders. Program trading, used largely by big institutional investment firms, allowed huge stock trade orders to be executed in specific market conditions (even volatile conditions, which was the case for Black Monday of 1987.) With big stock trades - most of them 'sell' orders - exploding on the market during a period of major chaos, Black Monday only grew more threatening.
The Day After Black Monday
It's worth noting that the stock market crash of 1987 was much different than the crash of 1929. The latter market collapse did much more lasting damage to the economy and to the stock markets, which took almost 25 years to fully recover from the crash of 1929.
In contrast, the Black Monday crash of 1987 didn't have the sustained, negative impact, with the Dow regaining 288 points within three trading days, and recovering all stock market losses by September, 1989.
Additionally, the U.S. economy didn't suffer lasting damage, with not even a small recession following the October crash. That's due in large part to immediate intervention from the Federal Reserve, which cut interest rates and stabilized the financial markets.
The Federal Reserve also signaled that its doors were open for loans and capital available for financial institutions that were at risk of imploding. On Oct. 20, 1987, Federal Reserve Chairman Alan Greenspan made this statement, which had a calming influence on the financial markets: "The Federal Reserve, consistent with its responsibilities as the nation's central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system."
The support from the Federal Reserve also enabled banks to lend money without worry of default, which gave the markets and the U.S. economy a much-needed shot on the arm, and, more important, reinforced the notion that the U.S. economy was operating in a "business as usual" environment.
The Takeaway of Black Monday for Today
While stock market crashes remain a fact of life for investors, consumers, businesses, and market exchanges, financial industry regulators did learn from the Black Monday crash of 1987.
Shorter-term fixes like the circuit-breaker market shut down policy led to stronger, sustainable fixes. For example, program trading was reined in, and derivate-heavy portfolio insurance programs were moderated, as well.
The lessons for actual Main Street investors were valuable, too. "Flash crashes" like the single day collapse of the Dow on Black Monday taught investors to spread portfolio risk around and showed the goal going forward would be to build an investment portfolio that could withstand the extreme conditions investors experienced in October, 1987.
The lessons did take hold, and even with the Lehman Brothers crash of 2008, investors learned to have more faith in the financial markets and understood the best move to make was to remain calm, remain in the market, and allow short-term market gyrations to self-correct.
That strategy worked in 1987 and it worked again in 2008, as the stock market rocketed to greater heights after a one-year period of recovery during the Great Recession.
As bad as Black Monday was in 1987, the lessons learned still provide a good blueprint for investors to follow today, when markets turn volatile, as they always do.