In recent days there has been much reflection about the twenty-fifth anniversary of “Black Monday”, 19 October 1987, the date which saw the biggest ever one day falls in global stock markets. Black Monday saw the S&P 500 Index decline by more than 20 per cent in a day and the Hong Kong market slump a staggering 45 per cent by month end.
While much of this navel gazing down memory lane has focused on the almost omen like Great Storm that wreaked havoc across the UK immediately prior to the crash and the raw emotion of feeling that civilisation was coming to an end as stocks lurched downwards in successive waves, its worth reflecting on the causes and asking “could this happen again?”
A number of factors are believed to have contributed to Black Monday. These included over-exuberant and overvalued markets which had rocketed 40 per cent in the nine months prior the event hitting a brick wall of worse than expected US trade deficit data and rising interest rates globally. However, the single biggest finger was pointed at “Programme Trading” strategies which, ironically, were meant to provide “portfolio insurance” by automatically selling shares when prices fell in order to limit losses. In doing so these triggered wave after wave of lemming-like selling.
The nature of market participants has changed dramatically since 1987. Gone are the days when long-term fundamental investors, such as insurance companies and pension funds, are the big movers and shakers in markets. The kings of dealing activity are now hedge funds, quantitative or systematic investment strategies and high speed algorithmic traders. Seemingly the potential for waves of massive automated selling has increased.
Of course the nature of regulation has also changed as well and the robustness of operational control and risk management is infinitely better. But this is no guarantee of infallibility. The recent case of Knight Capital is a timely reminder. Believed to be one of the largest high-frequency traders in US equities, in August this year its systems went rogue causing major disruption in the prices of a myriad of US stock prices and resulting in the firm having to be rescued. And that was an isolated incident.
Could Black Monday happen again? The only rational answer has to be “never say never”.
Jason Hollands is managing director of business development and communications at Bestinvest