Re-visiting the 1987 stock market crash!
The 1987 market crash of the 20th century is regarded as one of the most tumultuous movement ever in the stock market history. On 19 October 1987, the S&P 500 Index nosedived around 20% of its value along with the future and options market which had a global effect.
The day is still famously known as Black Monday which is till date the steepest falls in the stock market since its inception. The Dow Jones Industrial Average (DJIA) went down 508 points or 22.8% of its value which is the largest drop of the index till date. So, how did market correction so far down the line to create a panic? Let’s rewind a bit..
Prior to the correction of 1987, the market was touching a new high and there was a bull run in the market for a longer period of time. This bull market run was fueled by a lower rate of interest, companies with deep pockets acquiring weaker companies. There were also a lot of leverage buyout deals happening along with mergers on the rise.
Richer businessmen started believing that they can be on top of the market by continuously making the right acquisitions, in any LBO (Leverage Buyout) deal. Companies could raise cheap capital by selling junk bonds in the open markets and getting the right price for it. But Junk bonds carried a high risk of default. Most of the companies issued IPO’s (Initial public offering) and FPO’s (Follow on public offering) to raise capital and to grow and expand the business.
The traders were also having a good time meeting targets as well as the bankers and the corporates. Wall Street was making some serious money at that time. The bullish run made the investors believe that the stock market would always go up and these investors were not aware of the bubble that could come as a consequence of this constant bull trend.
Finally, the euphoria broke.
The findings of SEC (Securities Exchange Commission) which revealed a number of insider trading deals created a wave of worry among many investors. At the same time, the country had a growing level of inflation. To prevent the inflation, the Federal Reserve raised the short term interest rate. As a result, hedgers and portfolio investors started hedging their position to protect themselves from another possible market downturn. As a consequence, on 19th October 1987, the stock market went down along with the future and options market which resulted in a massive downgrade of stocks and a high call of sell in the market. Investor confidence was lost and the market was trading in red on that day and drove away all the wealth of the investors.
Nearly $500 billion in market cap was eroded from the market from the Dow Jones Industrial Average (DJIA). Similar market reactions were noted across the globe. Many people lost millions of dollars instantly. The government’s announcements of inflation and budget deficit also fueled the fire in the market which led to instant selling of all those junk bonds and shares which led to decline in the prices. Another factor was the record margin calls that accompanied the large price changes. The economy went into a slump and the government decided to intervene and introduce various policies and changes to prevent it from happening again.
After the crash, the Federal Reserve decided to intervene. The short term interest rates were lowered in order to prevent the liquidity crunch in the market by making access to cheaper credit. The markets recovered quickly after the crash and by the end of the fiscal year, the Dow-Jones showed a steep recovery by again climbing up. However, the crash showed the weakness in the economy of the country.
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