Lessons From Black Monday


Thirty years ago today, the Dow Jones industrial average incurred its largest single-day percentage-point drop. The blue-chip average plunged by more than 22%. The losses were not just restricted to stocks either, as the futures market was roiled by traders who incorrectly bet on arbitrage strategies. The massive losses resulted in October 19, 1987, being infamously referred to as Black Monday.

Since that time, there have been fears about it recurring. Technology makes it faster and easier to trade from anywhere at any time from just about any internet-connected device. Exchange-traded funds (ETFs) and automated trading programs have enabled hedge funds, large trading firms and other big investors to quickly jump in and out of the market. The use of options has expanded. At the same time, it’schart difficult to argue that humans have become more rational or less risk averse. The fear-driven herd behavior that drove the Dow down on Black Monday could resurface. At the same time, so could the rapid recovery that followed Black Monday.

While history does not necessarily repeat, it often has many sequels. This is why I believe an understanding of market history can help you better put whatever happens in the future into context and, more importantly, know when to react and when not to. With this in mind, I am republishing some observations about the 1987 crash I wrote five years ago along with a few notes added to them.

High valuations mean more risk—During the first nine months of 1987, stocks rallied by more than 30%. This led to price-earnings ratios on large-cap stocks rising above 20 and dividend yields falling to the lowest levels ever seen during the 20th century at that time, as Richard Fontaine (then a fund manager with T. Rowe Price) explained in the January 1988 AAII Journal. (Note: As of yesterday, the S&P 500’s year-to-date gain for 2017 was 14.4% and the price-earnings ratio was 20.2, but interest rates are significantly lower now than they were 30 years ago.) Continue Reading »

AII Model Portfolio Update

There are no changes this month to either the Model Shadow Stock Portfolio or Model Fund Portfolio. However, James Cloonan will discuss some important changes to the Model Fund Portfolio and rule changes to the Model Shadow Stock Portfolio in the November AAII Journal.

The Model Shadow Stock Portfolio, which is a real-money portfolio of micro-cap value stocks, climbed 11.0% in September. The Vanguard Small Cap Index fund (NAESX) added 4.4% for the month, and the DFA U.S. Micro Cap fund (DFSCX) was up 8.4% in September. Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 16.2% versus the Vanguard 500 Index fund’s (VFINX) gain of 9.3% per year on average over the same period.

The AAII Model Fund Portfolio gained 2.4% in September, compared to a 2.1% increase in the SPDR S&P 500 ETF (SPY). Since its inception in July 2003, the Model Fund Portfolio has a compound annual average return of 9.0%, while the SPDR S&P 500 ETF also has a 9.0% average annual return over the same period.

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 Highlights from this month’s AAII Journal

AAII Sentiment Survey

This week’s decline in bullish sentiment puts optimism below its historical average for the 36th time this year. More about this week’s results.
This week’s results:
  • Bullish: 37.9%, down 1.8 points
  • Neutral: 34.1%, up 0.8 points
  • Bearish: 27.9%, up 1.0 points

Historical averages:

  • Bullish: 38.5%
  • Neutral: 31.0%
  • Bearish: 30.5%

Take the Sentiment Survey.

The Week Ahead

Earnings season will hit full stride with 186 S&P 500 member companies scheduled to report. Included in this group are Dow components 3M Co. (MMM), Caterpillar Inc. (CAT), McDonald’s Corp. (MCD) and United Technologies Corp. (UTX) on Tuesday; Boeing Co. (BA), Coca-Cola Co. (KO) and Visa Inc. (V) on Wednesday; Intel Corp. (INTC) and Microsoft Corp. (MSFT) on Thursday; Chevron Corp. (CVX), Exxon Mobil Corp. (XOM) and Merck & Co. Inc. (MRK) on Friday.

The week’s first economic report will be the October Composite Purchasing Managers’ Index (PMI), released on Tuesday. Wednesday will feature September durable goods orders and September new home sales. September international trade and September pending home sales index will be released on Thursday. Ending the week, we’ll get the first look at third-quarter GDP (expect the hurricanes to have an impact) and the University of Michigan’s final October Consumer Sentiment Survey on Friday.

Only one Federal Reserve official will make a public appearance this week: Minneapolis president Neel Kashkari will speak on Thursday.

The Treasury Department will auction $26 billion of two-year notes on Tuesday, $15 billion of two-year floating rate notes (FRN) and $34 billion of five-year notes on Wednesday and $28 billion of seven-year notes on Thursday.

Local Chapter Meetings

AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you! Upcoming Meetings »


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