2,600 point drop in the DOW

[Deleted]

It does help put in perspective some of the wild gyrations that we have seen in the market lately. It is not the first time that the market has been wild, nor is it the last.


Could you stomach a 2,600 point drop in the Dow?
October 19, 2011, 1:21 PM

Anyone younger than their mid-40s probably doesn’t remember what happened 24 years ago today, since they were not yet out of college. This includes most mutual fund managers, by the way. But they should nevertheless study what happened on October 19, 1987 — a day that came to be known as Black Monday.

The Dow Jones Industrial Average INDU that day dropped 508 points, which at first blush might not seem all that noteworthy. After all, the Dow on a couple of occasions in recent months dropped at least that much.

But the Dow was a lot lower in 1987, which meant that the 508-point drop that day was far bigger in percentage terms—22.6%, in fact.

If a similarly-sized plunge were to occur at today’s lofty levels, the Dow would drop more than 2,600 points.

Such an extraordinary plunge may strike you as most unlikely, and you’d be right. But we’re kidding ourselves if we think that another drop of that magnitude won’t happen again.

In fact, according to a fascinating body of research (championed in large part by Xavier Gabaix, a finance professor at New York University) plunges as big as 1987’s Black Monday—while rare—are an inherent part of the investment landscape.

Gabaix discovered that the frequency with which huge plunges occur follows a well-known tendency known as Zipf’s Law. A crash like 1987’s, for example, will occur once very 75 years or so, on average.

Because this is an average frequency over many years, Zipf’s Law doesn’t tell us when the next crash will occur. But it does mean that we need to arrange our financial affairs on the assumption that another one, some day, will take place.

-Mark Hulbert

[kman]

Sounds good to me Archie. Always ready to take advantage with an appropriate ETF.

[flow5]

Black Monday Oct. 19, 1987.

Monetary flows (our means-of-payment money X’s the transactions rate of turnover), fell from 16 in AUG to 4 in NOV. Simultaneously (in the months Sept. & Oct 87 prior to the crash), the rate-of-changes in the proxy for real-gDp declined significantly sharper than in any prior period (since Jan 1918 or the last 70 years). The proxy declined from 11 in JUL to (-)4 in OCT.

The preceding contractionary monetary policy (FFR & discount rates were both raised .5% on 9/4/1987) – combined with the sharp reduction in short-term money flows, had forced all interest rates up in the short run (at the same time as inflation was subsiding).

30 year conventional mortgages yields had recently risen to 11.26 percent, & moody's 30 year AAA corporate bonds rose to yield 11.06 percent by 10/19/87 (this was the cause in the divergence of in the STOCK/BOND RATIO).

Greenspan had just forced a large contraction in liquidity (Greenspan made a very large error which he had to erase that day). Bank squaring day was the actual trigger.

I'd say there's very little chance of so many errors ever combining to cause another huge downturn.

[rovo]

I remember it well. I was very nervous for the preceding week and had sold out of most of my positions. At the height of the decline I was on the phone with my broker and buying Call options in Intel as well as re-buying most of the stocks I wanted. I don't remember the exact amount but I made a lot of $ in one day.


ETA: The next day when I sold my options the broker said she screwed up and I didn't have "option privileges", meaning I couldn't buy options. However, they let the round trip go through because it was their error.

[frankq]

Yeah, I remember it too. It was in the same category of stuff that causes you to remember where you were when it happened.

[Deleted]

At that time, the bulk of my assets were in unqualified annuities. The small % that was in stocks was treated like my usual response to any big rise or spectacular fall, I did nothing. One year later it meant nothing. Today on that big of a % drop I would be buying like crazy at the end of the day. (yeah, I'm still annoyed that I was on a media free day trip with the wife on the day of the flash crash.)

[Small Biz Owner]

2,600 point drop is nothing. DJIA dropped 7,721 points from Oct 2007 to Mar 2009.

The only reason for our current partial rebound? Stimulus money. Billions or even Trillions of it. Which was being forced into the Wall street financial sectors to try and make the appearance that everything was going to be normal. Thank you Helicopter Ben, Paulson and Geithner.

Nothing is normal about our current markets! Our markets are currently steroid pumped full of borrowed stimulus money. With the no new increased debt ceilings, the steroid money is beginning to wear off.

We are still down this year over 1,000 points from 12,800 high in April of 2011.

[Deleted]

Oh yes, I lived in the northeast then - The effects of Black Monday on that region lasted a couple of years. A lot of people lost a lot of money, houses, cars, etc. Seemed like there were huge Wall St layoffs too. I remember people bicycling around with signs that said things like "my other car used to be a Mercedes".

I was broke then, so I really only had a little 401K money in market, but I felt the effects when a year later I was relocating and had to sell my house - that was my first introduction to the fact that the value of homes does not always go up. Seeing it first hand helped me make more conservative decisions over the years (with respect to real estate).

[Deleted]

toughtimes - are you even old enough to have been working when Black Monday 1987 happened? The region most certainly did not recover in a couple months. The stock market didn't recover for 2 years, real estate was down for 2-3 years (houses were on market for many many months and not selling), Financial sector employees were laid off in droves - it wasn't pretty.

I will not argue that 9-11 was a bigger impact in all ways - it was the most devastating event occurring in my lifetime. There is yet no recovery from the events of that day.

[rovo]

Rock It, I think you are mistaken on the info you posted. The effects of the '87 dip were short lived.

[bean29]

My Memories of Black Monday are vague to non-existent. I was working, and had a 401K, but it was for my retirement and I was still in my 20's, so I guess I was not concerned.

But I am not sure that Rockit is wrong about the recession lasting several years. DH and I bought our first house in 91 and I swear when this housing recession started they pointed back to that time and said we were in a housing recession at that time. Our first interest rate was about 9%, and our first house was 49,000 bought on a single income and the PITI was under $500/month.

Wasn't there another historic drop in the early 90's I am thinking about 1992?

[Deleted]

National effects were short lived, but NY/CT (and maybe NJ) were affected for 2-3 years. Job losses were pretty much limited to the wall street gang & they regained jobs within a year or less. It was much less widespread than other economic impacts, but it was there. I'm going to say that the rest of the country was fairly oblivious to what was going on in the Northeast.