Remembering Black Monday

Already, there are no shortage of discussions about then and now. In this week's Barron's, Andrew Barry lays out the reasons why there probably won't be another day like Oct. 19, 1987 (even though it’s still a possibility). A 22.6 percent one-day drop in the Dow still stands out as an astonishing moment in the history of U.S. financial markets - as in, how could investors have kept selling? Didn't they realize the buying opportunities that day? (Frankly, they were in too much of a state of panic to consider the up sides.) Barry points out that by the end of that year, the Dow had regained 11 percentage points of its loss - and by the end of the following year, the DJIA was almost 25 percent higher than it was at the end of Black Monday. A buying opportunity indeed. Here's more:

One reason that monster declines are less likely now is that investors recognize something that they didn't in 1987: The Federal Reserve is on their side. When the markets were rocked this summer by fears about the economic impact of the subprime mortgage crisis, the central bank hesitated initially, but then did what Wall Street demanded and has come to expect: It provided liquidity and cut short-term interest rates. Helped by the Fed, the Dow has eclipsed its July peak of 14,000, ending Friday at 14,093, up 13% this year. And tech-share strength has powered the Nasdaq, which is up 16%, to 2,806.

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The U.S. economy is stronger now than it was in 1987, and Wall Street matters less globally, making stock markets abroad less vulnerable to shocks in the U.S. Globalization was still years away in 1987. Russia then was part of the communist Soviet Union, and much of Eastern Europe was under Moscow's thumb. China was emerging from the economic instability that lingered well after Mao's death, while India was captive to socialist policies that had prevailed since its independence in 1947. "I don't think there's a chance that the market can go down 22.6% in one day" now, says Byron Wien, the chief investment strategist at Pequot Capital Management in New York. "There is too much liquidity and too many buyers to cause a cascade like that."

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What could precipitate a 1987-style setback? The leading candidate is a major geopolitical shock. A U.S. attack on Iran, for instance, could drive oil prices past $100 a barrel, lead to wholesale liquidation of dollar assets by Middle Eastern investors and destabilize the region by drawing powers like Russia into the conflict. That, in turn, could set off a financial crisis by prompting wholesale liquidation of stocks by leveraged hedge funds and other investors, while putting enormous stress on the leveraged balance sheets of major banks and securities firms. Such a catastrophe could be worsened by the trillions of dollars of derivatives that Berkshire Hathaway CEO Warren Buffett has called "financial weapons of mass destruction."

There's another factor to be wary of: all the kids working on Wall Street who weren't around 20 years ago – and who tend to treat Black Monday the way many of us old farts treat the 1929 crash. Richard Weiss, chief investment officer at City National was at PaineWebber at the time in the firm’s asset allocation department. He tells Marketbeat that his firm was leaning away from stocks “and that was falling on deaf ears at the time, and then the crash hit, for whatever reason.”

One thing is for sure — it was a chaotic situation, sitting near the trading desk. “It was so frenetic at the time that traders were not leaving their desks — not that they weren’t allowed to, but they were not leaving even for bathroom breaks and they were given the, uh, necessary utensils to take care of things at their desks,” he says. “That’s not exaggeration — that’s how out of control it was.”