The Black Monday stock market crash in 1987 was one of the most unique and severe market phenomena that has taken place in U.S. and global economic history. The crash is said to have originated in the U.S., expanding globally, despite the fact that the first markets open to experience it were in China. There’s actually a lot of speculation as to what happened that fateful day as well as what caused it. In this article we’re going to discuss the events of Black Monday, how it happened, and what the aftermath looked like.
Monday, October 19, 1987, is the day that will forever be referred to as “Black Monday” because it is one of the greatest global stock market crashes in history. It’s important to note that not all stock markets at once, however, the world saw the biggest one-day percentage drop in United States stock market history.
On this day, the Dow Jones Industrial Average (DJIA) dropped a little over 22%. The Standard and Poor (S&P) 500 Index also suffered a monumental decline at 20.4%. Prior to Black Monday, the worst stock market crash in United States history had been the market crash of 1929, which was just over 12%. The devastation was nearly double that on Black Monday.
While the crash severely damaged the United States, this event heavily impacted every other stock market around the globe. Leading up to the stock market crash of 1987, the DJIA had tripled and then some, which is why the crash was so debilitating, causing the spark of fear around the world in terms of economic instability.
Five days leading up to the crash, there were sharp declines in the stock market, pressuring an onset of selling which came to a head that fateful autumn Monday morning. The significant selling created steep price declines, and the total trading volume was so massive that the computerized trading systems at the time weren’t able to process them.
This also left orders unfilled for hours, creating imbalances which prevented investors from learning the true price of the stocks.
Here’s where it tends to get a little hazy, which is why some stories about Black Monday vary. We were experiencing intensifying hostilities in the Persian Gulf, a fear of rising interest rates, a five-year bull market without a necessary correction, and the introduction of a technological program that allowed for computerized trading. We’ll go into more detail about that stuff later, as they have all been named as the absolute causes for the crash.
But there were also other profound economic factors that may have been to blame.
For starters, there was the Plaza Accord of 1985. Under the Plaza Accord of 1985, the Federal Reserve had an agreement with the central banks of what are referred to as the “G-5 nations.” The G-5 nations included France, Germany, the United Kingdom, and Japan. The agreement was to depreciate the U.S. dollar in international currency markets to help control surmounting U.S. trade deficits.
Early on in 1987, the goal to control the U.S.’s trade deficits had been achieved. At this point, the gap between U.S. exports and importance had worked themselves out, allowing U.S. exporters to contribute to the mid 80s stock market boom.
As we mentioned earlier, during the five years leading up to Black Monday in 1987, the DJIA more than tripled in its value. This created excessive levels of valuation as well as an overvalued stock market.
The Plaza Accord was also replaced by the Louvre Accord that February of 1987. The agreement under the Louvre Accord was that the G-5 nations would stabilize their exchange rates around this new trade balance.
As for the United States, the Federal Reserve tightened its monetary policy under this new agreement in order to slow the decreasing value of the U.S. dollar in the years inching towards the market crash. This resulted in a steep decline in growth for the U.S. money supply between January and September, causing interest rates to rise and stock prices to fall by the end of 1987’s third quarter.
There were many warning signs noted by investors during the trading days leading up to Black Monday. For example, on October 14, the DJIA began experiencing a decline of nearly 4%, dropping another 2.5% the following day.
On Friday October 16, just before Black Monday, the London stock markets experienced a devastating 5% loss. Interestingly enough, this loss coincided with the Great Storm of 1987, which was an unprecedented severe weather occurrence that gave way to hurricane-force winds in the English Channel. There were roughly two dozen deaths caused by this weather occurrence, and because it was so menacing, it’s forever linked to Black Monday.
Then, on Black Monday in 1987, the stock market crash began. Starting in Hong Kong, China, the crash rippled throughout all of Asia and during the Asian trading session. During this time, the other global markets began to feel the ripple effects of the initial crash as it spread throughout Europe once the London session opened.
By the time the U.S. stock markets opened for the day, every stock imaginable was in a freefall. By the end of the day, the DJIA dropped beyond 500 points and the S&P 500 had dropped over 55 points.
Of course, a lot of the more specific causes are only theorized by market analysts.
A Bull Market in Need of Correction The market analysts believe that the Black Monday stock market crash in 1987 was largely caused by a strong bull market, overdue for a major correction. This is because by 1987, the bull market had seen its fifth year without experiencing a single major corrective retracement of prices since it began in 1982. This causes stock prices to more than triple in value over four and half years time, rising by 44% alone in its fifth year just before the crash.
Automated “Program” Trading The next culprit that tracks in theory is that the severe crash was caused by computerized trading. Referred to as “program trading,” the concept of computers was still relatively new to the stock markets in the 1980s. Program trading is what allowed brokers to place large orders and exchange trades more quickly. Additionally, the software programs that were developed by banks, brokerages, and other firms were set up to automatically execute stop-loss orders, which would sell out positions if stocks dropped beyond a certain percentage. On Black Monday, the program trading systems more or less created a domino effect. This effect was the continual acceleration of the selling pace as the market was dropping, causing it to drop even further. The accelerated selling that was triggered by the initial losses causes stock prices to drop even further as well, which continuously triggered more rounds of computer-driven selling.
Portfolio Insurance Hedging The last contribution to the market crash in 1987 was essentially “portfolio insurance.” Much like the computerized program trading, portfolio insurance was also a relatively new concept at the time. Portfolio insurance revolved around larger institutional investors partially hedging their stock portfolios by taking up shorter positions in S&P 500 futures. These portfolio insurance “strategies” were designed to automatically increase investor’s short futures positions whenever there was a significant decline in stock prices. Once again, Black Monday triggered a domino effect within this new concept, much like the computerized trading program downfall. As stock prices began to decline, large investors automatically sold more and more of their short S&P 500 futures contracts. The downward spiral in the futures market put additional selling pressure on the stock market, triggering more investors to sell stocks and even more investors to short sell their stock futures.
Overall concerns about interest rates, oil prices, inflation, and trade deficits were in fact warning signs of increased volatility and infrequent but severe downfalls in the market prior to the Black Monday crash. However, the general cause of the crash was simply the fact that the markets didn’t just move upwards indefinitely.
Stocks became overvalued and the market was in desperate need of a price correction. However, because of the factors listed above, Black Monday turned into a sudden and severe explosion of a downward spiral—more so than anyone could have anticipated.
One of the most interesting things about Black Monday is the fact that it was so different compared to the other stock market crashes faced in the United States.
The stock market crash of 1929 had preceded and ultimately caused the Great Depression, which lasted roughly 10 years. The crash sent Wall Street into an uncontrollable panic, wiping out millions of investors and causing consumer spending and investing to drop. In turn this causes steep declines in industrial output as well as employment, causing failing companies to lay off their workers.
Then there was the market crash of 2008, when the DJIA fell a whopping 777.68 points in intraday trading. The market crash was ultimately caused because Congress rejected the bank bailout, but there’s quite a list of specific people to blame. However, it only took four years to recover from the 2008 market crash and the global recession it caused.
The 1987 recession caused by the Black Monday crash is unique because it was a much shorter-lived experience in the markets. The DJIA has recovered 288 points out of its 508 point loss, and under two years later, the stock market had recovered virtually all its losses. From there it was able to resume a strong bull market that would last for an entire decade, raising the DJIA above the 10,000 level.
Black Monday didn’t just trigger a severe market crash. It also triggered the development and implementation of “circuit breakers” worldwide. The purpose of the circuit breaker system was to avoid the type of widespread market panic that causes investors to begin recklessly selling shares from all their holdings. After all, this type of panic played a large role in the severity of the Black Monday crash.
Circuit breakers are a temporary measure put in place to temporarily stop trading in certain instances—i.e., when major stocks begin to decline by a specific percentage— to avoid the aforementioned panic and reckless selling.
For example, multiple circuit breakers are set up to halt trading when the S&P 500 index drops by 7%, 13%, and 20%, respectively. The first trigger causes trading to seize from the previous day’s closing price for up to 15 minutes. The second trigger will seize trading for an additional 15 minutes, and the third trigger—20%—will cease trading for the rest of the day.
In addition to the above market-level circuit breakers, there are also individual securities circuit breakers. These circuit breakers are triggered when the market moves up and down, and they include exchange-traded funds (ETFs). Individual circuit breakers range in tiers from 5% to 150%, with predefined parameters that will seize trading for five minutes at a time if any trading occurs outside of the parameters.
You can learn more about the predefined parameters here.
While we understand where we went wrong and have since then implemented security measures to prevent panic-selling, it’s not unlikely that we’ll experience other types of market crashes in the future.
Disclaimer: This content is intended for informational purposes. Before making any investment, you should do your own analysis.