Black Monday: what lessons have we learnt?
Black Monday 19 October 1987, is still seen as a defining moment in investment history. But what lessons can investors take from it and the subsequent 30 years?
In the months leading up to Black Monday on 19 October, global equity markets surged ahead with large gains on exchanges, from New York to Hong Kong. London still basked in the aftermath of the ‘Big Bang’ which de-regulated the City of London.
What started as a market correction in Asia, soon escalated into a complete rout. Institutions following a ‘Portfolio Insurance’ strategy, which prompted them to automatically sell down positions when triggers were hit to limit further losses, helped to drive the market lower.
On Black Monday, the UK market fell by 10.8% and by the following Monday the FTSE 100 was down 26.8% from the close just six trading days before.
Whilst markets certainly did crash, and there was much soul searching into the causes of it, what is often forgotten is that the UK market still managed to grind out a positive return for the year.
Over the next ten years to the end of 1997, the FTSE 100 shook off its previous woes, surviving both leaving the Exchange Rate Mechanism (ERM) and a recession, to return 262%. This hugely outpaced the 55% rise in the retail price index (RPI) measure of inflation.
This great contradiction of investing is that falling prices elicit feelings of fear, while rising prices are celebrated at great length and are a cause for emotional comfort. In fact the best response to any market crash is to avoid panicking; stocks getting cheaper — effectively trading at a discount to yesterday’s price — improves the outlook for future returns.
In the thirty years since Black Monday, the dotcom bubble and 2008 global financial crisis have illustrated that markets are still susceptible to both extreme risk—taking behaviour and short—term panic when things go wrong. A diversified portfolio will help shield you from the worst excesses, but investors now also have access to tools that were previously only available to the professionals.
Buying put options, which profit from falls in the markets, has never been easier. And with market volatility (a key input into pricing options) at or near record lows, it has never been cheaper to get that protection.
However, for many investors simplicity is the key to success. The famous $1 million Warren Buffett bet, that the S&P 500 index would outperform active investment managers over a ten—year period, had only one taker (a hedge fund) but was won earlier this year by a huge margin. Now virtually any index or theme is widely available on share dealing platforms in the form of exchange traded funds (ETFs). Taking this one step further, these instruments can be used as building blocks to create diversified portfolios of indexes protecting against concentration risk.
Online investment services can be used in conjunction with individual stock picking to provide a very cost effective ‘core’ and ‘satellite’ investment approach. Such an organised portfolio of ETFs, which was not available in 1987, offers a Buffett—like strategy for a fraction of the cost of traditional wealth managers.
While still a very rare outcome, a Black Monday occasion will probably happen to someone, somewhere, in the future. It’s how you manage this risk that is the key to long—term success. The ability to hedge market exposures, or simply making steady investments by ‘pound cost averaging’ over the long run can help protect investors from market shocks.
Macroeconomic events, political risk and natural disaster by their nature all have a habit of striking when we least expect it. We can’t plan for specific events, but we can prepare for their eventuality. One thing that is certain is that the pernicious effects of inflation will continue to eat into the savings of the meek and wary, taking on too little investment risk in the long-term can be just as dangerous as taking on too much in the short term.
In this respect little has changed from thirty years ago. However, times have moved on. Thirty years ago investing was expensive and only really available to the wealthy, the majority of the UK population would have viewed Black Monday from the sidelines. Nowadays platforms offering ISAs, SIPPs and regular investment accounts have opened up low—cost investment opportunities to all.