Stock Market Crash of 1987

The Stock Market Crash of 1987 is a good follow up to our article on the Stock Market Crash of 1929.  Some historians argue that there were similarities between the two crashes and we agree.  We also think that there were some distinct differences between the two crashes.  That being said, let's take a look at what was happening in the stock market 20 years ago.

The Stock Market before October 1987

In the first half of 1987, the U.S. dollar experienced a steep decline in value relative to other world currencies.  This made U.S. goods and services less expensive and resulted in increased exports. The increase in exports provided U.S. companies with a strong outlook on earnings and the stock market took off.

In fact, most of 1987 was marked with one stock market record after the other.  There had been a great deal of corporate restructuring in the years proceeding 1987 and American companies were promising strong future earnings growth.  International investors also took notice of the improvements in the U.S. market outlook and the rate of foreign investment doubled between 1986 and 1987, driving stock prices skyward.  By August, the Dow Jones Industrials was up over 800 points which translated into a 41% in rise in value.

In September 1987, the economic concerns over the weak dollar and rising interest rates started to make investors nervous.  Volatility in the market increased dramatically as both good and bad economic information hit the news.  A single day point gain record for the Dow was set on September 22nd only to be followed by the largest single day point loss on October 6th.  During the three days of October 14th - 16th the Dow fell over 260 points and the S&P 500 declined 10%, creating a great deal of anxiety over the weekend. Investors wondered what would happen on Monday.

October 19,1987 - Black Monday

On Monday October 19, 1987 the stock market plummeted right from the opening bell.  No one was looking to buy stocks that day and the problems in the stock market soon spread to the futures market.  The technology advances in the stock exchanges began to kick in and these computerized systems accelerated the decline.

Program trading was a new tool that was introduced to quickly take advantage of market movements.  On Black Monday, program trading moved millions of shares and clients as well as investment houses were left wondering what their actual market positions were like for most of the day.

Portfolio insurance professionals also contributed to the stock market crash of 1987 via their electronic trading systems.  As these computerized systems analyzed the event of the days prior to Black Monday, they flooded the market with sell orders early on Monday.

Portfolio insurance and program trading were intended to help investors take advantage of short-term market fluctuations.  Unfortunately, these two systems along with a lack of investor confidence drove the Dow Jones down 508 points - a 22% decline in value in just a single day.  Investors in the stock market would lose over $500 billion on that day alone.

What Caused the Stock Market Crash of 1987?

Following the stock crash, the federal government conducted a study of the events of Black Monday.  There was a great deal of concern and interest in figuring out what conditions contributed to the stock market's crashing.  After examining the findings of those reports, the SEC introduced several new measures of control into the stock market in an attempt to prevent a reoccurrence of the events of Black Monday:

• Computer Systems - Computer systems were upgraded in the stock exchanges to handle larger trading volumes in a more accurate and controlled manner.
• Margin Requirements - The SEC modified the margin requirements in an attempt to lower the volatility of common stocks, stock options and the futures market.
• Circuit Breakers - The New York Stock Exchange and the Chicago Mercantile Exchange introduced the concept of a circuit breaker.  The circuit breaker halts trading if the Dow declines a prescribed number of points for a prescribed amount of time.

As the market index rose over time, the original circuit breaker levels no longer made sense for these stock exchanges.  The current rules for the stock market can be found on the NYSE's website.

Rebounding from the 1987 Stock Market Crash

On a final note, the market rebounded remarkably following the 1987 stock market crash.  The market began a slow but stead climb almost immediately following the crash.  In fact, before the end of 1989, the Dow Jones Industrials would once again be setting new highs.

Most scholars attribute this rapid rebounding to the fact that the underlying fundamentals of the market were still strong and the Federal Reserve took quick action in the months following the crash to bolster international confidence in the American economy.

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