Adams Financial Concepts,  Current Events,  Super Cycle,  The Investment Industry

WHAT TO KNOW ABOUT THIS MARKET SELLOFF

“History doesn’t repeat itself, but it often rhymes”. I believe there are lessons to be learned from a previous time when the market, during a good economic time, plunged to the worst down day percentagewise in market history. It was the first time that the market plunge spread internationally to the world’s stock markets. There are lessons to be learned from Black Monday back on October 19, 1987. On that day, the market plunged down over 22%!

Black Monday is remembered as the worst market drop in history, but it was October 20, 1987 that had the potential to collapse the entire financial system. There is an old saying: “for every happy seller of a stock there is a happy buyer”. On October 19, it was reversed: “For every unhappy seller, there was an unhappy buyer”. When there is a sell off like October 19, 1987, or like the one recently this last Friday, and Monday, who is it that is the buyer? That is the crucial question to understand when the market will recover and begin to move up again.

First some background on Black Monday.

Economic growth had slowed from 7.2% in 1984 to 4.2% in 1985 and down to 3.5% in 1986. There were worries of an impending recession. Alan Greenspan had just been appointed Chairman of the Federal Reserve and it was rumored he was going to raise interest rates. The DOW Jones had risen from 790 in 1979 to 2,500 in mid-1987, an increase of over 340% from the bottom. There were concerns the stock market was overvalued; the bull market had been going for 8 years without a correction. There were concerns that Social Security was going to run out of money. There were concerns the trade balance and federal deficit were growing. Congress was considering eliminating tax breaks for debt used to mergers and acquisitions. And then, on October 19, 1987, US warships attacked an Iranian oil production facility in the Persian Gulf in response to a missile fired at an American ship.

Wall Street had developed new, sophisticated financial instruments that were aided by computer programs. Called “insurance”, they were programs that centered on the interplay between the stock markets and index options and futures. Traders had computers set to generate a basket of stock trades, at the instruction from the trader, the computers would send a batch of trades to the New York Stock Exchange or to Chicago Options Trading Pit. They were essentially built as hedges to take advantage of small differences in the options, futures and cash markets.

I had licensed in June of 1986 as a stockbroker and was a stock jockey at that time. I was cold calling and soliciting buys and sells of stocks and bonds. For stockbrokers, it was a transaction market, at that time. Fee-based accounts did not really exist for stockbrokers.

On Wednesday, October 14, 1987 the DOW dropped 95.46 points (3.8% to 2,412.7). That was a record down day. Then, the DOW finished down 58 points (2.4%). The DOW on that Thursday was down over 12% from August 25’s all-time high. Then, on Friday, the DOW fell 108.35 points without any rally. On October 19, 1987, Black Monday, the DOW plunged 22% in one day. That is still the largest down day in history.

I sat staring at my Quotron machine all day. Even at the time, I sensed that this was an historic event, and I was simply fascinated to see it unfold. The market traded down, rallied for a few minutes, traded down, rallied, and then traded down to close at the lowest point of the day.

Trading overpowered the capacity of the market. One of my clients had been a stockbroker in 1929, and he described to me that when the market crashed in 1929, the technology of the day had been overpowered, too. Trades were written on order slips and then transmitted by runners, and on October 24, 1929 – Black Thursday – there were so many trades that the exchanges had to rent hotel rooms. It took three days for them to sort and match trade orders with trade executions.

On October 19, 1987 trades overpowered technology. Traders thinking their trades had not executed hit the button again and again to sell a basket of stocks valued at $25 million. For the first time ever, there were a billion trades done in one day.

Who were the buyers? Market makers. Brokerage firms and exchanges are market makers. When there are sharp sell-offs, the market makers are required to be the buyers. Knowing that futures are opening down big, the market makers will set prices at which they feel they can buy the stocks being sold and turn around in the next few days or weeks to sell back at a profit.

October 20, 1987, brokerage firms did not have the cash or capital to pay for the stock they were forced to buy as market makers. Banks were ready to call loans and shut down all the brokerage firms, which would have collapsed the financial system. It was Alan Greenspan who forced the banking system to loan money to the brokerage firms to pay for the buy trades they had to make.

Understanding this is important to understanding how the market will heal. There is a huge inventory of stocks in market makers’ posession that they have to sell back to buyers. Until they get rid of their inventory, the market will not heal.

I caution you to beware of the gurus and talking heads in media.

The week of the crash, there was a mutual fund wholesaler who came into the PaineWebber office where I worked as a stockbroker. He said there was one trillion dollars of wealth wiped out on October 19. He stated we would be able to go into Nordstrom’s that weekend and hear a pin drop. That was the impact of losing a trillion dollars from the stock market. Or so he said.

I am a skeptic. When I went home, I related that story to my wife and said we needed to go to Nordstrom’s on the weekend. But when we did, we could hardly get into the store it was so packed with people. If a pin had dropped, no one would have noticed. But that was the mentality of the moment.

There was no CNBC in those days. I started to count the number of times one of the gurus or talking heads in newspapers, TV, radio, or magazines said the market was going to be down at the end of the year compared to the number that thought the market would be higher. My count was 68 predictions that the market was going to end the year lower to not one person who thought the market was going to be higher.

Today, the gurus and talking heads and CEOs are singing the same song of recession and depression. I have begun counting the number who are predicting recession and depression and further market declines. I just listened to one guru who was claiming we are facing a disaster, but at the same time he was buying stocks for his hedge fund. Was he trying to drive stocks down so he could buy them at lower prices?

Our market is being affected by a biological black swan. The Great Recession saw a relatively slow decline and recovery. That is very different from our current situation: our current decline was in rapid response to the coronavirus. Many governors and local officials began to act, and sporting events, concerts, and anything with over 250 attendees were either shut down or encouraged to shut down. Many people began to work from home and avoid crowds. People quit flying. Restaurants closed. Hotels were almost empty. Employees were laid off. The impact on the economy was almost immediate. I am guardedly optimistic the actions taken by government officials will slow and then turn the exponentially curve of illness.

This is very different economy from the Great Recession. The market upset now is going to be driven more by market makers getting rid of their inventories than an economic slowdown. Yes, the economy is being affected, but world government leaders are putting together aid packages to stimulate the world economy and restore the growth path on which it was moving.

In 1987, the year began at 1,927 and ended at 2,277, up over 18% for the year – even after Black Monday, which was the worst day in contemporary market history. Will the year 2020 end with a gain for the full year? It is possible. Worldwide central bankers and governments are implementing stimulus packages. All of that will be positive if the COVID-19 virus pandemic is brought under control within a reasonable time frame.

Now is the time to evaluate your investment portfolio. It may be time to make changes.

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