Stock Price Declines of 1987 and 2008 Compared

October 10, 2008

The Dow Jones Industrial Average has lost 23.0% over its last nine trading sessions in spite of gains of 4.7% on September 29th and 1.4% on October 6th.  That drop is very close to the single-day plunge of 22.6% on October 19, 1987.  That 22.6% drop culminated a short-lived but large overall decline of 36.1% from the prior cyclical high on August 25, 1987.  At 8,579 after today’s loss, the DJIA has fallen by 39.4% from its peak close of 14,165 exactly one year ago.  Both of these bear markets were associated with heavy and, in many cases, greater stock market declines in other countries.  If today were to mark the bottom, the two events could be considered as very similar.

However, one finds finds notable and disturbing differences on closer scrutiny.  The market this time had already been dropping for almost a year when the very steep part of the descent began.  Most people by late last month assumed a U.S. economy was in recession.  Jobs had fallen every month this year, and financial institutions were rocked earlier in September.  A recession was not anticipated in 1987 until after the 22.6% plunge, a much bigger drop than on the day of the infamous crash of 1929.  U.S. real GDP in 1987 rose 2.7% saar in the first quarter, 4.5% in the second quarter, 3.7% in the third quarter, and 7.2% in the quarter containing the 22.6% loss.  There would be no recession until August 1990, nearly three years later.  In the present period, GDP fell 0.2% in 4Q07, rose 0.9% in the first quarter of 2008, gained 2.8% in 2Q08, but is widely seen likely to drop by at least 1.0% at an annualized rate over 2H08 and to continue in recession into 2009.

Besides a much more worrisome economic and financial market backdrop, equity prices at the close of September 26th looked much less pricey than such did at the cyclical peak on August 25, 1987.  The close on September 26th of 11,143 was already lower than the 13-year bull run  peak of 11,723 on January 14, 2000.  From a cyclical low of 777 on August 12, 1982 to the peak of 2,722 some five years later, the index had soared 28.3% per annum.  After going essentially nowhere on balance between January 2000 and this past September 26th, the DJIA showed an annualized 10.7% rate of rise from that same August 1982 low.  The five-year advance in 1982-87 had gotten way ahead of itself, setting the stage for a badly needed correction to prick what had become an asset bubble.  This point does not apply to the present.  After the tumble of the past week, the DOW shows an annualized rate of increase of 9.6% from mid-August 1982 and 5.4% per annum over the forty-six plus years since mid-December 1961. Those changes, especially the last one, suggest the market is now very undervalued, but who wants to be first to catch a falling knife.

It is in the nature of markets to overshoot both up and down.  They will do this even if there is not good economic justification for a sharp correction as happened in 1987.  The present sell-off is associated with major ruptures in the U.S. and global economy.  1987 had some imbalances like the U.S. current account deficit and high and rising Treasury yields, but the primary factor for the bear market was the need for a good technical cleansing.


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