The Conditions that Led to Black Monday in October 1987

October 19, 2012

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Black Monday: The market fell 23%. Overnight, the crashes had followed the sun around the world; first, Hong Kong market, then the U.K., and finally the U.S.

Computer program trading and portfolio insurance was blamed for the 1987 crash. However, pressure had been building:

Euphoria was rampant headed into 1987. The market rose 250% in the five years before the 1987 crash without a significant correction. Speculative stocks with nothing but good stories led the way.

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The amount of corporate debt issuance doubled in 1986 from the previous year.

On the back of several Fed Interest rate hikes, As T-Bills rose to 7.79%, up 189 bps, ponzi finance ended. clip_image002

Insider trading scandals hurt market confidence. Corrupt practices ensnared: Kidder Peabody, Drexel, EF Hutton, Goldman Sachs, Jefferies & Co, and American Express Shearson Lehman.

The dollar sank throughout 1987 on budget and trade deficit concerns.

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Inflation concerns rose amid oil price spikes.

The market was highly leveraged, as below by the surge in margin buying. Brokers issued margin calls, forcing buyers to sell, accelerating the drop.

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The market fell 22.3%, with most major international markets hit.

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Implied Volatility Surged

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Still, the market finished 1987 higher on the year, recovering all losses within 2 years.

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Fool; Federal Reserve (PDF); Sniper

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