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BLACK MONDAY TENTH ANNIVERSARY

THE DOW, 1987-1997
Read Post stock-market stories from the past decade using our 10-year interactive chart of the Dow Jones Industrial Average.

Ten Years After Crash, Another Seems Unlikely

By Jill Dutt
Washington Post Staff Writer
Friday, October 17, 1997; Page A01

NEW YORK, Oct. 16 From a distance of 10 years, the Oct. 19, 1987, stock market crash looks like a small blip on a far-off horizon.

Sure, it was the single worst day in the stock market's history, with the Dow Jones industrial average losing 508 points, or 22.6 percent of its value. An equivalent event today would bash 1,800 points out of the average.

The crash scarred everyone remotely connected to Wall Street that day. But a new Washington Post-ABC News survey taken last week found that fewer than half of those polled could recall "Black Monday."

And why should they? The market rebounded quickly. The Dow climbed out of its hole, posted a small gain for that year and kept going, rising nearly fivefold in the ensuing decade with relatively minor hiccups along the way.

Not that the bumps aren't scary. Today, for example, a skittish market plummeted as much as 161 points on disappointing corporate earnings reports and Japanese trade tensions. The Dow finished the day below 8000 down 119.10 points, at 7938.88.

Before 1987, the nation's only previous experience with a sudden crash had been in 1929, which had ushered in the Great Depression and wiped out a significant chunk of a generation's wealth.

What arose from the 1987 crash was a new conventional wisdom about equity investing: Stock prices rise as companies grow; the prices eventually reach excess levels, and then they correct themselves. Investors who buy and hold for the long term will be rewarded.

Today's investors seem convinced that the best strategy in times of turmoil is simply to hold on. This conviction is one of the biggest reasons why many experts believe the next sell-off whenever it comes will not repeat 1987. These experts also note that the underlying structure of the markets today is much stronger than it was 10 yearsago and better able to handle any mass stampede to the exits.

"There's a much broader base of constituents in the market, so although we could have a drop of similar magnitude, it probably won't happen so fast," said Samuel Hunter, senior vice president at OptiMark Technologies, a Durango, Colo.-based firm that is launching a new trade-matching system for institutional investors.

Back in 1987, Hunter headed the equity trading desk at Drexel Burnham Lambert Inc., which racked up millions of dollars of paper losses when traders aggressively bought shares during a pause in the carnage midday on that Oct. 19.

"A day like that one is a once-in-a-century phenomenon," Hunter said.

An Ominous Pattern

So he hopes. The surging bull market of the past three years looks similar by some measures to the run-up that occurred before the 1987 crash.

Few dispute that stock prices are awfully high relative to corporate earnings, with the Dow stocks trading at more than 21 times projected earnings for the full year. But there are several key differences between the two periods, as noted in a recent report by Bruce Steinberg, Merrill Lynch & Co.'s chief economist.

Inflation which erodes the value of financial assets is at only 2.2 percent and falling these days, while core inflation as measured by the consumer price index in 1987 was at 4 percent and rising. Similarly, interest rates were rising sharply in 1987, as the Federal Reserve tried to temper that inflation.

The bellwether U.S. Treasury bond was yielding more than 10 percent at the time of the crash, up from about 7.5 percent the year before. Today, rates generally are falling. The 30-year Treasury bond is yielding 6.4 percent, down from more than 7 percent earlier this year.

And there's more good news: The federal budget deficit is shrinking, the dollar is strengthening and corporations are far less debt-burdened than they were 10 years ago.

So even though the markets may look the same on paper, they are in fact very different.

"The equity market's trajectory in 1997 is eerily reminiscent of 1987," Steinberg said. "Yet in nearly every relevant respect, current economic conditions are utterly different and vastly superior to those in 1987."

Steinberg expects stock prices to continue rising. But inevitably there will come a time when such optimistic views will change when economic conditions deteriorate, corporate earnings evaporate or an unexpected event changes everything. What will happen then?

This is where subtle but important changes in the market's structure come in.

"The other side of this is going to be ugly. No doubt about it. This has been the greatest ride of most people's lifetimes," said Jeffrey Tabak, managing partner of Miller Tabak Hirsch + Co., which executes sophisticated trading strategies using futures and options contracts for institutional clients.

"But can the markets handle a bear market? Yeah. From a structural standpoint, the markets can handle that."

For one thing, Tabak noted, big institutions are no longer following just one or two kinds of trading strategies as they were in 1987, when the new fad was computerized "program trading," which allows investors to buy or sell hundreds of stocks at one time.

In 1987, pension funds were enamored with a new trading concept called "portfolio insurance." In theory, the strategy protected an investor from losses in a declining market because users could sell futures contracts that would rise in value if stock prices fell.

But the strategy accelerated the market's drop as selling begot more selling.

But today "there is nothing . . . that leads one to believe there's a structural problem coming from that," Tabak added. Indeed, he noted the most popular portfolio-protecting trading strategies today tend to put upward, not downward, pressure on the market.

The New York Stock Exchange, in coordination with other markets, has also installed "circuit breakers" that will give investors a chance to step back and assess market conditions after any sudden, sharp decline. The exchange will close for 30 minutes if the Dow drops 350 points and for an hour if it continues to decline another 200 points.

The exchange also has dramatically expanded its capacity to trade shares. NYSE Chairman Richard Grasso said the exchange now could handle trading of more than 3 billion shares in a day if it had to nearly five times the 604 million shares that traded on Oct. 19, 1987.

Some simple changes also will help in the event of a steep market decline. William Brodsky, chief executive of the Chicago Board Options Exchange, said the major exchanges now are connected to each other, as well as to the Securities and Exchange Commission and the Commodity Futures Trading Commission, via a speakerphone that stays on continuously throughout the trading day. If one market official wants to talk to another, they simply flip a switch.

Still, Brodsky says the best protection for the market these days is the growing sophistication in investor attitudes. More people are investing with a long-term perspective, for retirement.

"You just don't see individuals selling stocks during a downturn," he said.

© Copyright 1997 The Washington Post Company

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