Recessions and the Market Aftermath Part 3


Who Remembers 1987?

I guess I am showing my age as I like to look back and reflect on earlier times.

We all do it.

As researchers Johannes Mahr and Gergely Csibra write in their paper “Witnessing, Remembering, and Testifying: Why the Past is Special for Human Beings”:

“The past is undeniably special for human beings. To a large extent, both individuals and collectives define themselves through history. Moreover, humans seem to have a special way of cognitively representing the past: episodic memory. As opposed to other ways of representing knowledge, remembering the past in episodic memory brings with it the ability to become a witness. Episodic memory allows us to determine what of our knowledge about the past comes from our own experience and thereby what parts of the past we can give testimony about.”

I think that is true. We become a witness so we can share our experience in the hopes of helping others.

1987. Seems like so long ago. When you consider that in 1987 the median price of a new house was $92k, the average income $24k, and a pound of bacon was $1.80, it confirms it was a long time ago! 😢And…gas was 89 cents a gallon. Oh, and 1987 was the first year of The Simpsons (and Full House).


For investors, 1987 was a memorable market year with Black Monday on October 19, 1987 when the Dow Jones crashed 22.6% in a single day. “On that day, stockbrokers in New York, London, Hong Kong, Berlin, Tokyo and just about any other city with an exchange stared at the figures running across their displays with a growing sense of dread.” (Investopedia)


The cause of the crash is up for debate among economist and academics but it was thought to be attributed by computer program-driven trading algorithms and models “that followed a portfolio insurance strategy as well as investor panic.” The cold, stark hard reality is that investor got pummeled regarding their portfolio returns. (See monthly returns below for 1987 - source here).


Buffet Wisdom

In his 1987 Christmas letter to investors, Warren Buffet wrote:

“During 1987 the stock market was an area of much excitement but little net movement: The Dow advanced 2.3% for the year. You are aware, of course, of the roller coaster ride that produced this minor change. Mr. Market was on a manic rampage until October and then experienced a sudden, massive seizure.

We have "professional" investors, those who manage many billions, to thank for most of this turmoil. Instead of focusing on what businesses will do in the years ahead, many prestigious money managers now focus on what they expect other money managers to do in the days ahead. For them, stocks are merely tokens in a game, like the thimble and flatiron in Monopoly.


An extreme example of what their attitude leads to is "portfolio insurance," a money-management strategy that many leading investment advisors embraced in 1986-1987. This strategy - which is simply an exotically-labeled version of the small speculator's stop-loss order dictates that ever increasing portions of a stock portfolio, or their index-future equivalents, be sold as prices decline. The strategy says nothing else matters: A downtick of a given magnitude automatically produces a huge sell order. According to the Brady Report, $60 billion to $90 billion of equities were poised on this hair trigger in mid-October of 1987.

If you've thought that investment advisors were hired to invest, you may be bewildered by this technique. After buying a farm, would a rational owner next order his real estate agent to start selling off pieces of it whenever a neighboring property was sold at a lower price? Or would you sell your house to whatever bidder was available at 9:31 on some morning merely because at 9:30 a similar house sold for less than it would have brought on the previous day?

Moves like that, however, are what portfolio insurance tells a pension fund or university to make when it owns a portion of enterprises such as Ford or General Electric. The less these companies are being valued at, says this approach, the more vigorously they should be sold. As a "logical" corollary, the approach commands the institutions to repurchase these companies - I'm not making this up - once their prices have rebounded significantly. Considering that huge sums are controlled by managers following such Alice-in-Wonderland practices, is it any surprise that markets sometimes behave in aberrational fashion?”

Stock market returns between 1987 and 1997

If you invested $100 in the S&P 500 at the beginning of 1987, you would have about $496.94 at the end of 1997, assuming you reinvested all dividends. This is a return on investment of 396.94%, or 15.69% per year. If you used dollar-cost averaging (monthly) instead of a lump-sum investment, you'd have $463.17. This investment result beats inflation during this period for an inflation-adjusted return of about 251.73% cumulatively, or 12.11% per year. (Source)


The Lesson

  1. Staying the course and ignoring short-term market volatility is a loser’s game. As the great Charles Ellis once said, “when stocks get cheaper it is bound to be good news for long-term investors.”
  2. Computer driven investment algorithms cannot predict human behavior.
  3. When things are volatile and the market is gyrating, take a breather and reflect back on your own experience in investing—as the wisdom writer says, “there is nothing new under the sun.”