On Thursday the 15th of October 1987 BBC weather forecaster, Michael Fish, laughed off a viewer's suggestion that a hurricane was about to hit the south of England. As it transpired, a storm of gigantic proportions was about to break out over the UK and financial markets globally. By the morning of the 16th, 15 million trees had been blown down with Sevenoaks in Kent becoming "One Oak". By the evening of the following Monday, many global equity markets had fallen by 30%.
As I walked to work on the Friday morning the overnight winds had moderated but it was still blowing hard. Scaffolding was hanging precariously off buildings and awnings were flapping in the wind. I arrived at my office to find the power out, resulting in me having to walk up to the thirteenth floor. I worked for a Japanese Bank that was due to launch a new bond issue that morning and I was the only one in. Finding a telephone that worked, I called the Tokyo office and all they wanted to know was how much of the issue we had sold. At first they refused to believe me when I said the deal could not go ahead. Who was this junior salesman to tell them that they could not do it? I explained that I was looking out across the city and the only light I could see was emergency lighting and that no one would be in. As the morning progressed, I took calls from people who could not get in. With trees down across roads and railway lines there was no chance for anyone to commute, unless they could walk, and with power out and markets effectively closed not much that could be done if they did get in.
On the Friday afternoon the US stock market fell 5%, but in London the focus was still on the storm damage. Between January and July the UK and US stock markets had risen more than 40%. In response to the strong economy, the Federal Reserve had raised interest rates and the stock market had sold off a little. In light of interest rates moving higher than expected and tensions rising in the Middle East, the stock market had begun to sell off more in the week leading up to the hurricane. With virtually no one at work in London on Friday, UK investors came in on Monday wanting to sell stock and the market makers pulled any bids. Later that Monday, the US market opened significantly down only to be followed by programs, originally created with the intention of protecting portfolios, generating automatic sales causing the market to fall further. This eventually resulted in the day closing down 20%. By close of business on the Tuesday, the FTSE 100 index had lost 21% from the previous Thursday. The Volatility index on the S&P 100 (the predecessor of the often quoted VIX index), which is often seen as a measure of fear in the market closed at 150. To put this into context, when the financial crisis hit in 2008/9 the VIX peaked at 87 and is currently in single figures today. As can be imagined, the market was in panic mode and equity trading was nearly impossible. Trade reconciliation and settlement meant that many people worked through the night for the next two days. Even in Hong Kong the index was down 40% in a week.
In the aftermath, central banks around the world cut rates and since that time every significant down turn in equity markets has been met by central bank rate cuts and each time, as the market has recovered, the peak in rates has been lower. The S&P 500 ended the year positive and within two years was reaching new highs. Ten years after the crash it was over 300% above the 1987 low. Looking at a 12 month chart covering the crash, the impact is undeniably dramatic. However, in the long-term the 1987 crash, however intense at the time, looks like a small blip.
So what does this teach us? Here are some of the lessons of 1987:
- Markets that go up a lot can have sharp corrections;
- Do not sell when everyone panics;
- Do not extrapolate one market move into another without checking the logic; and
- When the going gets hard central banks target asset prices.