In the world of finance, "Black Monday" refers to Monday, 19 October 1987. Black Monday was a fateful day for U.S. equities, led by the Dow Jones Industrial Average (DJIA) and S&P 500 experiencing their largest single day declines in history. For the trading session, the DJIA registered more than a 22% loss in value, and the S&P 500 closed down 20.4%. The rapid sell off in U.S. stocks was the result of many factors and part of a major global correction in equities.
Black Monday has been a storied event in U.S. financial history. Commonly dubbed as "Wall Street's first modern crash," it has been the focus of many books and movies as well as extensive academic study.
Actually, there are two "Black Mondays." The first one occurred on October 28, 1929, and was the largest one-day percentage drop in the DJIA until the 1987 crash and is still the second largest on record. Unlike the 1987 crash, whose economic consequences were rather benign and the market quickly recovered, the 1929 crash triggered the Great Depression, which would last 10 years and lead to the failure of half of America's banks and massive unemployment. From their peak in September 1929, stocks would fall by 90% over the next several years and not fully recover until 1954.
Dating to its origins in 1896, the DJIA has represented the performance of elite publicly traded American companies. It is viewed as one of the leading global indices and serves as a barometer for the entire U.S. economy. The DJIA has experienced many crashes over the course of its history, with the severity of Black Monday ranking near the top of the list:
- Black Monday, 19 October 1987: -508.00 DJIA drop (-22.61%)
- Crash of 1929, 28 October 1929: -38.33 DJIA drop (-12.82%)
- Crash of 1929, 29 October 1929: -30.57 DJIA drop (-11.73%)
- Black Monday fallout, 26 October 1987: -156.83 DJIA drop (-8.04%)
- 9/11 attack, 16 September 2011: -684.81 DJIA drop (-7.13%)
- Global debt crisis, 15 October 2008: -733.08 DJIA drop (-7.87%)
- Global debt crisis, 1 December 2008: -679.95 DJIA drop (-7.70%)
The size and scope of the losses incurred on Black Monday are staggering. In comparison to modern valuations of the DJIA, the decline on 19 October 1987 equates to a one-day deficit of more than 5,000 index points. By a wide margin, Black Monday remains one of the most severe stock market crashes in U.S. and world history.
The panic created by investors during Black Monday acted as a precursor for disaster in the international markets. For the trading sessions of 19 and 20 October, several leading international equities indices experienced massive losses:
- Great Britain, FTSE 100: -22.8%
- Germany, DAX 30: -10.8%
- France, CAC40: -9.5%
- Japan, Tokyo Stocks: -17.3%
- Hong Kong, Hong Kong Stocks: -11.1%
- Australia, ASX All-Ordinaries: -28.7%
- Canada, Main Index: -18%
While the damage to American equities was extensive, international markets were not given any quarter by traders and investors. Black Monday, also referred to as Black Tuesday depending upon geographic locale, was truly a global phenomenon.
Black Monday: Causes And Effects
The events of 19 October 1987 inspired vigorous debate and study regarding the stability of the existing financial system. Since its occurrence, the root cause of Black Monday has been a hotly debated topic among industry experts, historians and regulatory bodies.
However, several theories that address the reasons for the crash are commonly deemed relevant by the consensus:
- Electronic Trading: The rise of electronic order entry systems greatly increased the speed at which trade was conducted. Large orders were able to be executed at market in short periods of time, a relatively new capability that contributed to the dramatic sell off.
- Derivatives: Futures and options index products failed to act in sync with their underlying asset, equities. As equities fell, derivatives fell faster, exacerbating the crash.
- Portfolio insurance: Many institutional investors had begun using portfolio insurance, which was designed to protect against losses but often encouraged excessive risk-taking. This new product also "included extensive use of options and derivatives and accelerated the crash's pace as initial losses led to further rounds of selling," according to the U.S. Federal Reserve (Fed).
- Challenges In Market Liquidity: Insufficient buyers were active in the market to absorb the massive selling. As a result, the trade of many listed stocks was restricted or terminated, furthering the loss in asset value.
- U.S. Budget Deficit: Statements made on 14 October by U.S. Treasury Secretary James Baker regarding the need for a "fall" in U.S. dollar valuations preceded a sharp rise in interest rates. Concerns over a coming trade imbalance and growing national debt ensued, prompting many investors to take positions in the bond markets.
Each of these elements is likely to have played an individual role in creating the conditions for a plunge in U.S. equities valuations. While it may not be possible to isolate a single cause, market historians cite Black Monday as being the culmination of a wide variety of factors.
Shortly after the conclusion of Black Monday, the Presidential Task Force on Market Mechanisms, also known as the Brady Commission, was created. The task force investigated the events of Black Monday in-depth, crafting an official report of its findings. The report issued several recommendations designed to limit the impact of future market volatilities and eliminate financial catastrophe:
- Creation of an intermarket regulatory body
- Unification of transaction clearing systems
- Standardisation of margin requirements
- Implementation of circuit breakers
- Establishment of connected information systems
Many of the recommendations outlined by the task force have become functioning parts of the U.S. financial system. Circuit breakers, margin requirements and standardised clearing have all been implemented in contemporary finance. In addition, the U.S. Federal Reserve (FED) conducts extensive market oversight acting as the proposed intermarket regulatory body.
Fed Reaction To Black Monday
The Fed's respective reactions to both Black Monday crashes were very different and set the stage for how it deals with future crises. In 1929, the Fed raised interest rates, which some believe panicked investors. It also made it more difficult for banks to lend money. This forced investors to liquidate their holdings, which exacerbated the selling.
In 1987, however, the Fed lowered interest rates and "affirmed its readiness to serve as a source of liquidity to support the economic and financial system," Fed Chair Alan Greenspan announced the day after the crash, hoping to calm investors' nerves.
In addition, "behind the scenes, the Fed encouraged banks to continue to lend on their usual terms," the Fed says. Ben Bernanke, Greenspan's successor as Fed chair, wrote in 1990 that the 10 largest Wall Street banks nearly doubled their loans to securities firms during the week of the crash, which "was a good strategy for the preservation of the system as a whole" even though the banks may have lost money in the process. The Fed's response set a precedent for its use of liquidity to stem future financial crises, a tactic it used during the financial crisis of 2008 and continues to employ.
Even though Black Monday was the largest single-session loss in U.S. equities value in history, the market proved resilient. By the end of October 1987, the DJIA was up 15% from the 19th October close. A little more than two years later, the DJIA eclipsed pre-crash levels. While certainly a devastating financial event, Black Monday is given credit for being the beginning of a pronounced bull run in U.S. equities.
The lessons of Black Monday still linger in the background of the modern financial landscape. Since that time, many changes to the markets have been made to ensure crashes occur infrequently. While the stability of U.S. and global equities has not been tested to the degree of Black Monday since October 1987, only time will tell if the safeguards are a success.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…