Back to the Black Swan and October 1987

Steve Kanaval |

Sully.jpgWhen planes crash, all investigators note the succession of events that led to the crash. In most cases they learn the that crash occurred due to an unlikely series of unexpected events, followed by pilot error causing the eventual demise. Yesterday’s stock market similarly had a series of events which were unrelated yet undeniably damaging. But as of this morning, pre-market trading US equities seem to be rising above it. It seems Sully Sullenberger was flying yesterday’s plane, before safely landing it on the Hudson River.

You have a looming Greek default potentially eliminating the Euro as we know it. Also, Chinese stocks experiencing a Dot Com-type bubble. Meanwhile, the United Airlines ($UAL) ticket system is blowing up and stranding passengers at O'Hare in Chicago and spreading to other airports at the exact same time that the NYSE order routing system for customers caused a shutdown of a large portion of trading in US stocks. This makes it look like a coordinated cyberattack was in full scale action - it was a volatile morning on July 8th, right after the July 4th holiday in the states, and most trading desks still had B-Team players filling in for those in the Hamptons. Yet, the markets shook it all off, and fast news dissemination on Twitter Inc. ($TWTR) showed the value of social media.

But in the world of equity trading, today is another day with stocks in China leading a rally back from the steep selloff, NYSE glitches behind us and all is quiet on the western front as futures are up in pre-market trading. It is a testament to how markets have changed since 1987 and also smacks of US-based retail investors not biting on the first set of panic news they see – unlike their Chinese counter parts – who have been bailing with both hands.

A Case of History Repeating

I can tell you that the 1987 stock market crash started exactly like yesterday's action in October 1987, where a series of currency moves and political errors caused the US-based futures markets to gap lower. This contraction in premium caused immediate selling in stocks on the open sending futures to discounted cash levels where computer trading systems had no choice but to unwind their positions until the NYSE shut down the computers. 

But the rout was on during that Black Monday in October, closing down 25%. These were the days where the dangers of derivatives came to light and the media kept showing photos of traders with hands on their heads. Even I save a photo of my Bloomberg screen showing stocks at levels we would never see again on that day taken with a Polaroid camera. I have that framed on my wall to remind me that the black swan is always swimming nearby.

All seems well for now as China bounces, Greece dangles, glitches repair and Sully Sullenberger lands a broken plane on the Hudson River not losing one passenger to the delight of the media and everyone watching. But beware how fragile the markets can be. A slight change in the tipping point can easily cause the order of the market to come undone creating the arrival of the black swan – she is there – hanging on my wall.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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