October may not be the cruelest month for investors -- based on the averages, that's September. But when Wall Street stumbles at this point of the year, it stumbles extra hard. And that's why Alison Southwick and Robert Brokamp picked October for a four-part series on the history of market crashes in the United States.
In this podcast, guest and Former Fool Morgan Housel leads the discussion as they reflect on two major economic tumbles: the long downturn of the 1970s and 1987's Black Monday. Coming into the 1980s, Fed Chairman Paul Volcker jacked up interest rates to unheard-of levels in an effort to break the back of inflation. Eventually, that succeeded, leading the economy into a powerful boom. But all good things come to an end -- in this case, on Oct. 19, 1987. (Then again, did it really end then?)
A full transcript follows the video.
This video was recorded on Oct. 10, 2017.
Alison Southwick: It's the '80s! We're going on our next stop in this tour.
Morgan Housel: Miles per gallon is up to 8 miles a gallon now. We've improved a little bit.
Robert Brokamp: Progress.
Southwick: We're not even talking cars. We're taking our yachts everywhere. The '70s were a bummer, so we're going to go someplace a heck of a lot more fun, and that's the '80s. Everyone is doing cocaine, like I mentioned. They're yachting to their jobs on Wall Street. Greed is good. Shoulder pads are huge.
Housel: Did you say everyone was doing cocaine in the '80s?
Southwick: Yeah, that's what I know about the '80s.
Housel: Let's just move on.
Brokamp: You were alive in the '80s. Were you doing cocaine? Maybe we shouldn't talk about this on the internet.
Southwick: I was a toddler. But no, if you watch the old movies and the old TV shows, everything is all big and glitzy. And anyway, it was this huge party that was never going to end, probably because of the cocaine, so here we go. We're coming up into October 1987.
Housel: Stocks have done incredibly well for the past five years at this point. Four or five years. Stock prices had about tripled at this point. The unemployment rate had come way down. Reagan is very popular as a president because of, I think, the economic performance at the time. Again, back to what Bro was saying about "animal spirits." I like tracking what is the average mood is at the time. And in the '50s and '60s, it was great. The '70s was really bad.
The '80s went to great again. People were really optimistic about the economy. What was happening in the United States and the stock market? This was during the peak when Japan was really looking like it was going to lead the world. I think there was some anxiety about that, but the U.S. in terms of innovation and growth was distinctly No. 2 at this point, even though it was a much larger economy. But overall there was quite a bit of optimism. The stock market had done really well right up to October 1987.
Southwick: All right. Are we ready? Are we ready for October 1987? Which, of course, is exactly 30 years ago ...
Brokamp: That's right ...
Southwick: ... when this podcast is airing.
Housel: Yeah, that's right.
Southwick: So it's sweater weather in New York City, and what happens?
Housel: I think one of the really interesting parts about this is it was Alan Greenspan's third day on the job.
Housel: Alan Greenspan is in charge of the U.S. economy and everything that ties into it at this point. And his background before he joined the Fed was, he was basically an academic. He was an economic consultant, but not that much experience in high levels of politics, where you have to deal with all the different dynamics of politics. So I imagine being thrust into the Fed chairman job, at that point, when you don't have a heavy background in politics, and then 72 hours into the job the stock market fell more than 20% in one day.
Southwick: Why? Why did it do that?
Housel: Do you know what's interesting about the crash of 1987? This is true for the crash of 1929, too. Thirty years later, people are still debating why it happened, and there's not a lot of consensus about why it happened. Maybe this, too, gets back to the "animal spirits" of sometimes the stories that we tell ourselves change really quickly.
If there was one technical aspect that happened in '87, there was a thing in the 1980s that was really popular called portfolio insurance, which was a product that's not around anymore. It was a terrible idea. But it was effectively an insurance policy that if you owned stocks you had an insurance policy against it, and if the stocks fell by a certain amount, you had an insurance policy that would sell a basket of stocks and repay. It was a really complicated arrangement that tried to de-risk investing as a lot of investment products do.
But the practical reality of it was that if stocks started falling a little bit, these stock insurance policies would sell stocks to make up for those losses, and then it just snowballed on itself. Losses triggered selling, which triggered more losses, which triggered more selling. It happened really quick. And this is at the very early bleeding edge of when people were using computers to invest, both to execute trades and to see what was going on in the world.
I mean, computers in 1987 were absolutely archaic compared to today, but before that and for all of history, the stock market was entirely face-to-face. You had traders on the floor that would literally yell at each other to trade orders, and this was the first time that it was computers that were starting to make some of the decisions.
And from what I understand -- and again, there's not a lot of consensus about this, but because it was so early, the computers that were set up doing this had no idea what they were doing and just weren't -- they didn't communicate with each other very well, were prone to all kinds of glitches. The architecture of it wasn't really thought out very well, and it just kind of fed on itself in one day, to where selling begat more selling, and the next thing you know it feeds on itself. And that just creates fear among human investors, not the computers that were selling, that causes them to sell. And it just spreads from there.
And the pervasive view after this happened, the day of the crash of '87, go back and read the newspapers. Everything had the same headline, was, "This is the crash of 1929, and we're going back into the Great Depression." That was the view that everyone had back then. And it makes a lot of sense, because that was effectively how the crash of 1929 started. You had a big run-up in the '20s, and also overnight, everything then comes to an end.
Southwick: But that didn't happen, right?
Housel: The really amazing thing about the crash of 1987 is that I think eight months later, the market was back at an all-time high. Like if you look at a long-term chart of the stock market, you can barely see '87.
Housel: It's like a dot that barely happened.
Brokamp: The stock market actually made money for the whole year.
Housel: In that year and in 1988, as well.
Southwick: Is it maybe just a matter of great branding? Like being able to say "Black Monday!" Like if hadn't been named Black Monday, would we have forgotten about it?
Housel: It gave journalists something to talk about. But that's really the amazing thing, is that in hindsight it was nothing. It didn't really do anything to the economy. It didn't really do much to the stock market within eight months. Like when we talk about the Great Depression, we talk about the human suffering. The unemployment. When people talk about the crash of '87, it's mostly just for entertainment, honestly, because not much came from it. But if anything, it's just a show of the disconnect that often happens between what companies and businesses are doing and what stock prices do as they react to the architecture of the stock market that is independent from the businesses that people are investing in.
Southwick: In the summer of 1988, I was a sophomore in college and I worked for my high school English teacher's husband, who was a broker for Merrill Lynch. I was just doing errands, and cold-calling for seminars and stuff like that. But I remember the event of 1987, and it stuck with me, No. 1, that stocks were too risky. And I remember saying to him, "Isn't this just all a bunch of gambling?" And I got a good lecture about why investing isn't gambling.
But when I look back on that day, most people did not have computers to check stock prices. There was no CNBC. You didn't know the price of your stock unless you called up your broker or you waited until the newspaper the next day. I think people back then felt a little bit more out of control, because they didn't know what was going on. They might have seen on the news that the Dow dropped, but they didn't necessarily know what their individual stocks did, and they couldn't just get on their computer and sell if they wanted to. They had to wait until they could get their broker on the phone to make the transaction.
So I think when you think of investing back then, people felt a little bit more like they didn't have as much control over what was going on and felt like a little bit more of a victim of these big drops in their portfolios.
Housel: I often wonder, though. I agree with that, but I think there is a devil's advocate to make. People have so much information today that maybe they have too much.
Brokamp: I think that's possible, yes.
Southwick: And it's so much easier to buy and sell.
Housel: The fact that you can just be at the gym and then get a push alert on your phone that says the Dow is down 100 points. That's not healthy...
Southwick: Then pick a different app and say, "Sell, sell, sell."
Housel: When you buy an iPhone, there aren't that many apps that come preinstalled, but one of them, that's right on the home screen for everyone, is a stock app.
Brokamp: Is a stock app, yes.
Housel: Which is cool. I like that. But I think that mentality or just what that brings to a lot of people, is unhealthy. It's something people didn't have 30 years ago, constantly being tied into it, especially because so much of what is, quote-unquote, "news" today is just commentary, and that's even charitable. It's just opinion. And especially around crashes -- the crash of 2009 and whatnot -- there's a big thing in the pundit world where people wanted to be, particularly around 2009, everyone wanted to be the guy to go on CNBC and say that the world's coming to an end. This hasn't even begun yet. We're going to go back to the Great Depression. That person got famous. So I think the amount of commentary we have today is probably unhealthy compared to what it was back then.
Brokamp: I think I spent half my days back then answering calls from clients giving stock quotes. And you'd get some people who'd call back every day and you knew the 10 stocks that they owned, so you'd just run them down.
Southwick: But how would you do it? Did you have a computer?
Housel: He just made it up.
Brokamp: They had what they called a Quotron.
Southwick: He's just like, "I don't know..."
Brokamp: Of course, I had some dice. I'd roll them. I had my 20-sided D&D dice.
Southwick: So you caused Black Monday.
Brokamp: Exactly. I had something called the Quotron.
Southwick: The Quotron. I love it. It didn't have a number after that? The Quotron 3000?
Housel: The Quotron 4000.
Brokamp: Maybe it did. And you just put it in and then you got a number again.