Monday, 19 October 1987, known as “Black Monday,” remains a watershed moment in financial history. While it played out 37 years ago, fears of a recurrence are just a thought away.
This week’s key themes:
- Should we be on edge?
- Markets position for two 25-basis point rate cuts by the end of the year
- Higher-than-expected jobless claims pose questions about US labour market resilience
- Gold rebounds, while oil continues to seesaw between supply concerns and demand woes
- Dollar buoyed by US CPI data
A LOOK BACK AT 1987 AND PARALLELS TO TODAY’S FINANCIAL CLIMATE
On that fateful day in October 1987, the Dow Jones Industrial Average plunged by a shocking 22.6% in one day—the largest single-day percentage drop in United States (US) stock market history. Billions of dollars were wiped out in hours, and markets around the globe followed suit in a mass panic.
However, the markets rebounded surprisingly quickly, and regulatory changes followed to prevent a similar collapse in the future. Today, with increasing concerns about overvalued assets and high interest rates, there are compelling parallels between 1987 and the current financial environment. What can history tell us about today’s risks, and how has the regulatory landscape evolved?
What triggered the 1987 crash?
The 1987 crash wasn’t caused by a single factor but by a combination of conditions.
- Overvaluation and excessive optimism: Prior to the crash, the stock market had been on an extraordinary upward run, with prices soaring beyond sustainable levels. Investors were emboldened by robust economic data, which led to irrational exuberance.
- Program trading: One of the most significant accelerants of the crash was program trading, a new form of automated trading that automatically triggered large-scale selloffs when prices fell. This system was meant to limit losses, but instead, it created a feedback loop where selling caused more selling.
- Rising interest rates: Throughout 1987, the US Federal Reserve (Fed) had steadily raised interest rates, making borrowing more expensive. This shift made bonds more attractive than stocks, putting additional pressure on the equity markets.
- International tensions: Worries over trade imbalances and volatile currency markets, particularly between the US, Japan, and Germany, added to the overall sense of instability.
All these elements created a perfect storm, but the dramatic crash also laid bare the vulnerabilities of financial markets, leading to swift changes in regulation.
Post-crash regulatory changes
In the aftermath of the 1987 crash, regulators quickly moved to implement safeguards to prevent a recurrence of Black Monday. These reforms primarily focused on curbing the volatility caused by automated trading and enhancing market stability during periods of extreme fluctuations.
- Circuit breakers: Perhaps the most important regulatory change was the introduction of market-wide circuit breakers. These mechanisms paused trading during extreme market declines to give investors time to process information and avoid panic-driven selling. In their initial form, trading halts were triggered by large percentage drops in major stock indices, with the goal of cooling off markets and preventing the kind of rapid, cascading selloffs that occurred in 1987.
- Limitations on program trading: Regulators also put limits on certain types of program trading, particularly those that contributed to the self-reinforcing selloffs. This aimed to temper the role of computerised algorithms, which could overwhelm human decision-making during market stress.
- Transparency and coordination: The 1987 crash highlighted the need for better communication between financial institutions, regulators, and exchanges. Regulatory bodies like the Securities and Exchange Commission introduced measures to ensure greater transparency in trading practices and coordinated efforts across global markets to stabilise trading during periods of distress.
How do today’s circuit breakers differ?
While circuit breakers were introduced following the 1987 crash, they have since been refined and modernised to better manage today’s faster, more interconnected markets.
- Tiered breakers: The original system applied a single threshold for triggering a market pause. Today’s circuit breakers are more sophisticated, using a tiered system. They halt trading at three different levels based on how much the S&P 500 declines within a single trading day—at 7%, 13%, and 20% drops, respectively. Each tier results in progressively longer halts, providing more time for markets to stabilise.
- Pre-open and post-close adjustments: Current circuit breakers also apply to pre-market and post-market trading, whereas the original circuit breakers only applied during regular trading hours. This ensures that the increased volume of after-hours trading is also regulated, which wasn’t a major concern back in 1987.
- Global synchronisation: Given that financial markets are more globalised now than they were in 1987, circuit breakers today are designed with a broader, international focus. Exchanges around the world can coordinate halts, reducing the risk of one market’s crash spilling over into another uncontrollably.
What contributed to the swift recovery after the 1987 crash?
Despite the dramatic nature of the 1987 crash, the markets recovered far more quickly than expected. Several factors contributed to this.
- Federal Reserve intervention: The swift action of the Fed was a crucial factor in restoring confidence. Then-Fed Chairman, Alan Greenspan, issued a statement on October 20, 1987, saying that the central bank stood ready to provide liquidity to support the financial system. This assurance helped ease fears and stopped the panic from spiralling further. The Fed’s aggressive monetary easing afterwards also helped prop up markets.
- Corporate buybacks: Many corporations took advantage of the lower stock prices to repurchase shares, thereby reducing supply in the market and stabilising prices. These buybacks also signalled confidence from companies in their own valuations, helping to restore investor trust.
- Strong economic fundamentals: Despite the crash, the underlying economic fundamentals in 1987 were relatively sound. There was no major recession on the horizon, inflation was under control, and corporate earnings were strong. This helped limit the fallout, and once the panic subsided, investors returned to the markets, confident in the long-term growth prospects.
Parallels to today’s financial environment
While much has changed since 1987, some similarities in the current market landscape are hard to ignore.
- High valuations and speculative behaviour: Just as in 1987, today’s markets have seen sharp increases in stock prices, with many sectors—particularly technology—reaching valuations that seem unsustainable. Speculative assets like cryptocurrencies and meme stocks have also added to market froth.
- Algorithmic trading: The role of automated trading is even more pronounced today than it was in 1987. High-frequency trading dominates a large share of daily market volume. While algorithms provide liquidity, they could also amplify volatility during market stress, much like program trading did in 1987.
- High interest rates and persistent inflation fears: Just as rising rates in 1987 added to market uncertainty, today’s environment of tight monetary policy and higher inflation poses similar risks. Investors worry that the era of cheap money, which has fuelled much of the stock market boom, could be coming to an end.
A final thought
The 1987 crash serves as a vivid reminder of how quickly financial markets can unravel. The regulatory changes that followed—particularly the introduction of circuit breakers—have helped mitigate the risk of having a repetition of such a dramatic event. However, as today’s markets face similar challenges—overvaluation, high interest rates, and algorithm-driven volatility—investors should remain vigilant. The crash of 1987 may be in the past, but its lessons remain relevant in the ever-evolving financial landscape. As the saying here at Citadel goes, the future will surprise.
ZOOMING IN ON THE MARKET
The financial markets are always in a state of flux, driven by myriad factors, from economic data releases to geopolitical developments. Below, we take a look at the most noteworthy movements at the time of writing.
US 10-year bond yields remain near a two-month high
Bond markets have been responding to a wave of fresh economic data, with yields moving in tandem with inflation expectations and central bank actions.
The yield on the US 10-year Treasury note fell slightly to 4.07%, after briefly touching the 4.1% mark. This move came as markets digested an unexpected rise in US unemployment claims, which raised concerns about the strength of the US labour market, particularly following recent hurricanes in the US southeast. Despite the drop, the 10-year yield remained close to its two-month high, as long-term inflation concerns and potential Fed rate decisions kept investors cautious. The US inflation rate for September slowed to 2.4%, just above expectations, but was high enough to raise questions about the Fed’s monetary policy path. Markets are now pricing in the likelihood that the Fed will end the year with a Federal Funds rate capped at 4.5%, anticipating two 25-basis point rate cuts by the end of 2024.
In the UK, the 10-year gilt yield stayed above 4.2%, hovering near three-month highs. This movement tracked US bond yields as traders re-evaluated expectations of Fed rate cuts following higher-than-expected US inflation data. Meanwhile, there’s growing anticipation that the Bank of England (BoE) will take a more aggressive stance on rate cuts if inflation continues to ease. Governor Andrew Bailey has hinted that such cuts could be on the horizon, particularly after holding rates steady at 5% in September.
South Africa’s 10-year government bond yield rose to around 9.4%, its highest level since early August. The local bond market reflected similar global trends, with investors reducing expectations for aggressive Fed rate cuts after the stronger-than-expected US jobs report. Locally, the South African Reserve Bank (SARB) recently initiated its first interest rate cut since 2020, responding to a slowdown in inflation. Further easing is anticipated in November, with a gradual rate-cutting cycle likely to extend through to 2026.
Inflation and jobless data weigh on stocks
Equities were under pressure as traders digested mixed inflation data and a rise in jobless claims, with major indices posting losses.
During early trade on Thursday, US equities slid 0.3% as investors reacted to a Consumer Price Index (CPI) report showing that inflation was slightly higher than expected. The report highlighted core inflation edging up to 3.3%, which unsettled traders. The increase in jobless claims—reaching a 14-month high of 258,000—added to concerns about economic resilience. The industrial and technology sectors were the worst performers, while utilities and energy stocks outperformed. Delta Airlines’ shares fell 1.8% after the airline issued disappointing fourth-quarter revenue guidance.
The FTSE 100 in London was relatively flat, sticking around the 8,250 mark as investors reacted cautiously to the US inflation data. Healthcare stocks led the gains, with global biopharma group, GSK surging nearly 5% after agreeing to settle lawsuits related to its discontinued heartburn pharmaceutical Zantac. On the other hand, house builder, Vistry, saw a sharp 5% drop after warning of underestimated building costs.
Over in Germany, the DAX was down 0.1%, with major companies like defence industry systems supplier Rheinmetall and package delivery and supply-chain management company, Deutsche Post, dragging the index lower.
Gold rebounds from three-week low
Commodity markets have been grappling with both supply concerns and macroeconomic factors, which have led to a mixed performance in oil and gold.
Brent crude oil futures rebounded to around $77/barrel after two consecutive losing sessions. This recovery was driven by concerns over supply risks, particularly due to the ongoing conflict involving Iran and possible supply disruptions from Hurricane Milton. However, rising crude inventories in the US and a cautious demand outlook—especially after China’s lacklustre stimulus measures—tempered the rally. The US Energy Information Administration also slashed its demand forecast for 2025, citing slowdowns in key economies.
Gold prices edged higher, rebounding to $2,615/ounce after touching a three-week low. The precious metal benefitted from the mixed economic data in the US, particularly the rise in unemployment claims, which challenged the notion that the US labour market was immune to higher interest rates.
Dollar and euro trade on central bank signals
Currency markets remained volatile this week as traders focused on diverging central bank policies and economic data.
The US Dollar Index initially fell when markets opened on Thursday but recovered to trade near 102.9, buoyed by the higher-than-expected US CPI report. The annual US inflation rate rose to 2.4%, with core inflation also exceeding forecasts, leading traders to expect a slower pace of Fed rate cuts. The likelihood of a 25-basis point rate cut in November currently stands at 86%, according to Fed Funds futures.
The euro weakened further, trading near the $1.093/€ mark, extending its bearish run. Expectations that the European Central Bank will cut rates, combined with ongoing growth concerns, weighed heavily on the currency.
The British pound also struggled, falling below $1.31/£. Traders anticipated a more dovish stance from the BoE, with Governor Bailey signalling more aggressive rate cuts ahead if inflation continues to ease. However, uncertainty over fiscal policy and upcoming tax hikes dampened sentiment.
The South African rand weakened to around R17.60/$, pressured by the stronger greenback and ongoing uncertainty surrounding China’s economic outlook. The rand’s performance was also influenced by the anticipation of further SARB rate cuts.
Key Indicators:
USD/ZAR: 17.51
EUR/ZAR: 19.15
GBP/ZAR: 22.85
GOLD: $2,645.41
BRENT CRUDE: $78.84
Sources: Bloomberg, Reuters, Trading Economics, Federal Reserve and Investopedia.
Written by – Citadel Advisory Partner and Citadel Global Director, Bianca Botes.