From the December 01, 2011 issue of Futures Magazine • Subscribe!

How to get active in long-term investing

Crash of 1987

The first half of 1987 witnessed a sharp decline in the U.S. dollar and a subsequent increase in U.S. exports, which provided extra earnings to the companies and gave stocks a boost. Corporate restructuring and promises of strong growth further bolstered expectations and prices. The foreign investment rate doubled from 1986 to 1987 and in August alone, the Dow increased by 41% (800 points).

In September 1987, rising interest rates and the continually weak dollar worried investors. Volatility in the markets surged. On Sept. 22, the Dow had a record single-day gain. On Oct. 6, it suffered a record single-day loss. Then, on Oct. 19 — Black Monday — the stock market sank quickly. Volume and volatility spread through the futures market as stock buyers dried up. Program trading and portfolio insurance made the situation worse, with automated systems swamping the market with sell orders. The Dow fell by 508 points (22%), causing losses of more than $500 billion.

Numerous regulations emerged from subsequent investigations. The Securities and Exchange Commission (SEC) issued a number of changes; the technological infrastructure of the stock markets was upgraded; margin requirements were modified; circuit breakers that would stop trading following a specified drop were implemented.

After the ‘87 crash, the market recovered amazingly, rising slowly and steadily with the Dow recording a new high before the end of 1989. This recovery was credited to strong market fundamentals and timely action by the Federal Reserve to boost the international faith in the U.S. economy.

The dot-com bubble

The 2000-02 bear market can be traced to the economic growth following the 1991 recession. Among the keys to the Clinton era were moving U.S. borrowing to the shorter end of the yield curve, which reduced borrowing costs and long-term rates. Additionally, President Bill Clinton’s open trade policies fueled economic growth.

On Feb. 17, 1993, Clinton revealed a budget plan that included lower deficits and tax increases. It was the largest deficit-cutting proposal in history, cutting $500 billion in four years. The budget was under control, and the dollar strengthened. Oil prices collapsed. Moreover, the North American Free Trade Agreement lowered tariffs on exports and imports. While we could argue the current loss of U.S. jobs was sparked by the effects of free trade, in the early days it served as a boost.

However, the biggest reason for the growth in the 1990s was the birth of the Internet. CompuServe, America Online and Prodigy were the early leaders. By 1996, 45 million people were online. This grew to 150 million by 1999. The growth in productivity was only part of the story. The bigger factor was the rampant speculation in the companies promising to lead the country into this brave, new frontier.

SEC records include 700+ failed e-commerce corporations. Surprisingly, more than 80% of the SEC listings were headed by dedicated, qualified and diligent managers. More than 90% of them got initial public offering funds, meaning the market considered their models credible.

The crash happened because investment vastly outpaced client acquisition, which came at exceptionally high cost. The public was slow to accept online shopping and found it confusing. In retrospect, this reluctance was not new. For example, despite being available since the mid-1970s, automated teller machines still only had a 50% use rate by the late 1980s. Despite great promises, the early investment rate in dot-com companies simply could not wait for demand to materialize. It didn’t help matters that these same companies emphasized brand awareness and neglected product/service strategies that actually create a market and serve customers.

Following the initial bursting of the dot-com bubble — further accelerated by the Fed increasing interest rates six times in 1999-2000 — the stock market had recovered by the time George W. Bush was elected. The Dow peaked at 11,723 on Jan. 14, 2000, and the Nasdaq hit 5,048 on March 10, 2000. Then, however, came the 9/11 terrorist attacks in 2011 and the economy sank into a deep recession. The market hit its low on Oct. 9, 2002, with the Dow at 7,286 and the Nasdaq at 1,114.

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