There are down days, and then there are catastrophic days. Every once in a while, a convergence of events conspires to drop the Dow Jones, S&P 500, and NASDAQ further than many traders would have imagined possible.
Big corrections can occur every year or two, but one particular day in history brought more than just a downward correction. It was, in fact, the worst single day for the major U.S. stock market indexes ever recorded.
It’s instructive to consider what happened on that fateful day and how quickly fear can spread. At the same time, looking back at what happened after the crash can provide valuable lessons and even make you a better investor.
This Was the Worst Day
You might assume that the worst one-day U.S. stock market drop must have occurred during the 1929 crash or the Great Depression that followed. However, in percentage terms and using the Dow Jones (which has a lengthy history) as the primary gauge, the deepest single-day collapse actually took place in the 1980s.
That’s right — some of you may have been around long enough to remember this horrendous day. It was October 19, 1987, and the crash was so severe that it’s still known to this day as Black Monday.
The erasure of wealth on that day is mind-boggling. Even the lessons supposedly learned after the Great Depression didn’t prevent the Black Monday rug pull.
How bad was October 19, 1987? The NASDAQ declined 11.35% and that was a single-day record, but this wasn’t even the worst major market index drop.
That same day, the S&P 500 slid 58 points or 30% and, believe it or not, the Dow Jones plummeted 508 points or 22.6%. Stock markets in other regions, from Hong Kong to Australia, also collapsed on Black Monday.
These numbers are important, but they don’t tell the full story. Hence, we need to explore the contributing factors that led to such a dreadful market event.
The Pitfalls of Globalization
Nowadays, it’s a cliché to say that stock markets around the world are interconnected. The drawdowns of 2008-2009 and 2020 reminded investors that when one nation sneezes, other countries can catch a cold.
That concept might not have been so obvious back in 1987, though. Consequently, market participants learned the hard way that globalization can have pitfalls, especially when panic spreads.
Clearly, traders weren’t prepared for a drawdown in October 1987 after the Dow Jones rose 44% in just seven months. The widespread complacency was a setup for disaster, and the initial trigger occurred when the U.S. government reported a worse-than-anticipated trade deficit in mid-October.
The dollar quickly lost value, and globalization took effect in the worst possible way. Asian stock markets dropped sharply before the U.S. market opened, allowing fear and dread to spread before the final collapse.
Furthermore, news reports on television certainly didn’t help to assuage traders’ concerns. Thomas Thrall, a senior professional at the Federal Reserve Bank of Chicago, explained, “It felt really scary… People started to understand the interconnectedness of markets around the globe.”
After Black Monday, circuit breakers were put into place to temporary halt the U.S. stock market when deep single-day declines happen. These circuit breakers didn’t exist in October 1987, so the market went into a state of free fall without due protections for investors.
After the Collapse
Today, it’s practically assumed that the Federal Reserve will inject liquidity into the banking system to shore up the stock market. This assurance wasn’t so commonplace in 1987, though.
Federal Reserve Chairman Alan Greenspan declared on October 20, 1987, that the nation’s central bank was ready to “serve as a source of liquidity to support the economic and financial system.” Years later, in 1990, Federal Reserve Chairman Benjamin Bernanke concluded that lending money to U.S. banks “was a good strategy for the preservation of the system as a whole.”
As you’ve probably figured out by now, the central bank’s policy of backstopping the stock market enabled equities to recover quickly after Black Monday. The Dow Jones regained 288 points or 57% of the total Black Monday decline in just two trading sessions.
Moreover, it took less than two years for the major U.S. stock market indexes to surpass their pre-Black-Monday highs. And while there were ups and downs, the market posted strong returns overall in the 1990s.
It just goes to show that resisting the urge to panic-sell at the worst possible time can allow ill-timed investors to recover their losses. Better yet, being patient and holding on for a while might turn a deep loss into substantial, eventual profits.