Image via Roger Hsu/Flickr CC
On October 19, 1987, the stock market crashed! During the ‘80s investors were making tons of money, and blinded by hubris were flaunting a “greed is good” attitude. The investment community at large had become complacent, even though there were signals along the way that indicated trouble was brewing. It was a historical Monday that I’ll always remember. I was running a small sales force of stockbrokers. Each morning we would have a brief meeting to establish our goals and get ourselves motivated; then we’d hit the phones making endless calls to potential investors and clients.
The stock market had been on a rip-roaring tear with the Dow Jones Industrial Average (DJIA) increasing 40% for the year. We were all young brokers in our mid-20s on that fateful day. We had only one quote machine for the office, and it was on my desk. The screen was blood red with every stock on the screen free-falling. We were totally transfixed and afraid. My colleagues asked me what I thought would be the outcome of this horrific market crash. I didn’t have a clue. I just sat there eating popcorn watching it all in utter disbelief. Here we are 30 years later, with market critics murmuring that it’s déjà vu all over again. Is it? Here are the stats: then and now.
Back then, our nation’s output as measured by gross domestic product (GDP) was more than double today’s rate. The CPI inflation rate started ’87 at 1.3% and climbed to over 4% by October (CPI is currently at 1.9%). The Federal Reserve raised short term rates even higher to keep the economy from overheating. This pushed intermediate and long term government bonds to 10%. Government-backed securities are considered the world’s safest investment. Ten-year treasury notes paying investors double-digits put tremendous pressure on stock prices. It was a turning point.
Shareholders began lightening up on their holdings in early October; by mid-month sell orders accelerated, and the DJIA posted 13% losses. The rapid rotation out of stocks and into high yielding safe bonds crescendoed on Black Monday the 19th. Panic struck full force. Intrepid and fearful traders alike dumped stocks in mass. Wall Street was pandemonium; by trading day’s end the Dow fell by 508 points or 22.6%. The DJIA was down 33% for the month. Immediately, the Federal Reserve aggressively cut interest rates sending a strong message to market participants that liquidity would be there when needed. Stock prices firmed in days to follow and six weeks later, by early January, the DJIA had recouped half its losses.
In ’87, ten-year treasuries paid 10.2% interest; now rates are 2.4%. Blue chip stocks currently pay 2% in dividends, comparable to the yields afforded bonds. Market analysts cite price-to-earnings (P/E) multiples when it comes to assessing market valuation. The S&P 500 stands at 21.2 now, versus 15.4 then. Is this reason for alarm? Economic growth was a strong 6.8% then, now GDP is sputtering along at 3.1%. Is today’s current P/E justifiable? Historically, higher inflation has been indicative of lower P/Es, such as in ’87, whereas higher P/E multiples have occurred during modest inflationary environments similar to now.
A grave concern that political opponents and market sages tout is the growing amount of federal debt. At closer inspection, the situation looks manageable. In 1987, interest payments made by the government amounted to 4.8% of total gross domestic product; today that figure is 2.5%. Is the federal debt situation really that dire?
As I’ve previously suggested in these letters, job growth is the engine that drives the economy. Job growth spawns investment, consumer spending, personal savings, innovation, and improved living standards; it reduces poverty. The economy added 1.5 million workers to payrolls this year, as the Fed incrementally upped interest rates; it is a quandary. There is a solution; it is what I call becoming a S.T.A.R.
S.T.A.R. investors prepare for multiple outcomes: inflationary and noninflationary growth scenarios. The acronym is the following: (S)eventy-five percent is the most, and twenty-five percent is the least, that a star investor will invest into the market at a given time. The idea is to load up on equities when values are low, and to lessen the load when prices are high. (T)ransitory minded investors accept the changes (taxation, fiscal policy, monetary policy, secular changes, the internet of things, demographics, et cetera), roll with them, and are flexible and adaptive. (A)ge and awareness matter. Invest your age in bonds. (R)otate and rebalance into uncorrelated asset classes.