Why the Stock Market Looked a Lot Better in October 1987 Than It Does Today

Roller coaster stock market - Business crisis diagramLast week, stock markets in the U.S. economy celebrated the 25th anniversary of Black Monday, a one-day market crash that happened on October 19, 1987. To celebrate the event, last Friday, the Dow Jones Industrial Average sold off more than 200 points—1.52% to be exact.

I remember the day of October 19, 1987 quite vividly. Back then, the transfer of information was slow because we didn’t have the Internet. But the economy was doing fine. There was plenty of room for the Federal Reserve to reduce interest rates. We thought it was a computer-generated market sell-off. I had started in the business just a couple of years earlier. I remember writing in the only newsletter I published back then, BUY.

I wish I could say the same about today’s stock market. And I’m certainly not the only one worried about a possible market sell-off. Since the first week of September until this past October 10, 2012, $25.6 billion has been withdrawn from U.S. stock market mutual funds. (Source: Investment Company Institute, October 17, 2012.) Since June, more than $74.0 billion has left the U.S. stock market.

On Black Monday, the Dow Jones Industrial Average dropped 23%. Investors sold in a panic, and about $1.0 trillion in stock market value was lost in a matter of four days due to the market sell-off.

Boy, was the popular media wrong about the ’87 crash. Here are some of the headlines from those days:

U.S. News & World Report: “After the Fall, Is a Recession Coming?”

Newsweek: “After the Crash…The Specter of Depression”

Time: “The Crash…the World is Different”

(I actually purchased these magazines back then and still have them in my office.)

Fast-forward to now; we are facing problems in the U.S. economy that are much worse than we faced in 1987. The stock markets of October 1987 and October 2012 have nothing in common!

I don’t have to go into detail (I’ve done that many times before on these pages) to tell you how the U.S. economy is slowing down and how, by next year, we could very well be in a recession, especially if the fiscal cliff isn’t averted.

In 1987, the average unemployment rate was 6.2% in the U.S. economy. The average unemployment rate this year so far is 8.2%. (Source: Bureau of Labor Statistics, October 19, 2012.) The U.S. was in much better shape 25 years ago.

I am not saying we are going to see a similar market sell-off like the one we saw in 1987. The stock exchanges have many measures in place now so that we can avoid such an extensive one-day sell-off again; circuit breakers now halt trading to stop an extensive market sell-off.

As we already know, back in 2008 and 2009, the market sell-off didn’t occur in one day. The stock markets in the U.S. economy continued their gradual slides for months. On some days, the Dow Jones Industrial Average plunged 700 points, and on other days, it went up by 300 points—volatility poured into the markets and trading ranges got bigger.

As the bear market rally in stocks that started in March of 2009 nears its end, I expect the downward move in stock prices to be slow and steady. The current earnings season, one of the worst I have seen, could act as a catalyst for the market sell-off, and key stock indices will slowly trickle downward. But don’t forget that, today, there are not many alternatives for investors to run to. Ten-year U.S. Treasuries pay under two percent.

Optimism can drive the markets higher, but when people start to see what’s really going on, they panic. Preserving your capital is the best strategy right now. Remember, the greatest returns only come after extensive market sell-offs, not during an uncertain rally.

Michael’s Personal Notes:

The notorious S&P 500 looks to be standing on the edge of a cliff. If you are familiar with technical analysis, what you will notice is that a significant amount of companies that make up the S&P 500 are breaking below the uptrend they were enjoying earlier this year.

For those not so familiar, in technical analysis terms, this means that the S&P 500 companies’ stock prices were making successive new highs, but are failing to do so now.

Why should you be cautious? Technical analysis suggests two main pointers about trends. The first is the old adage, “The trend is your friend,” to which I would like to add, “…until the trend is broken.” Secondly, don’t go against the trend, as a decisive trend can virtually go on forever. The S&P 500 companies that are breaking below their uptrend can potentially drag the whole index lower.

There are five companies that have a combined weight of more than 10% on the entire S&P 500 index. All five companies recently broke below their respective uptrends.

These S&P 500 companies I’m talking about are Apple Inc. (NASDAQ/AAPL), Google Inc. (NASDAW/GOOG), The Coca-Cola Company (NYSE/KO), Wells Fargo & Company (NYSE/WFC), and Microsoft Corporation (NASDAQ/MSFT).

To give you an idea, Apple, which carries a weight of a little higher than 4.5% on the S&P 500, was trending higher all year around, but recently it broke below the uptrend. If you look at the chart below, technical analysis would suggest that this move is certainly not in Apple’s favor. Apple’s stock has more weight on the S&P 500 than the material, telecom services, or utilities sectors. (Source: Standard & Poor’s, October 18, 2012.)

apple inc stock chart

Chart courtesy of www.StockCharts.com

If you look at the charts of the other S&P 500 companies that I mentioned earlier in this article, from a technical analysis perspective, you will find similar observations.

As I have been continuously writing, this earning season has been one of the worst I have seen in a long time. The S&P 500 looks to be stumbling. Economic conditions, earnings growth, revenue growth, and future expectations are not impressive. Sadly, things were looking better in mid-2009 than they are today.

Where the Market Stands; Where it’s Headed:

Why is it that some things never seem to be quite what they really are?

Back in 1987, three companies were included in the Dow Jones Industrial Average that are no longer there today: Bethlehem Steel Corp., Eastman Kodak Co., and General Motors Corp. What happened to these three companies? They all declared bankruptcy and were removed from the Dow Jones Industrial Average.

If I kept those three companies in the Dow Jones Industrial Average to compare apples to apples, the stock market, as measured by the Dow Jones from October 1987 to October 2012, would be a lot lower today than it is. And I thought just the employment numbers were fixed.

We are still in a bear market rally that started in March of 2009. That rally is getting old and tired, but the Fed is making sure it is kept alive.

What He Said:

“I’m getting very worried about the state of the U.S. housing market and its ramifications on the economy. The U.S. could be headed for its first outright annual decline in home prices on record, adjusted for inflation. And I really believe this could be a catastrophe for the U.S. economy.” Michael Lombardi in Profit Confidential, August 2, 2006. Michael started talking about and predicting the financial catastrophe we started experiencing in 2008 long before anyone else.