The Federal Reserve emergency lowered interest rates by 50 basis points and implemented quantitative easing to inject liquidity to "rescue the market". In the end, the 1987 major crash gradually subsided, and the risk did not spread to a larger range, but the danger lies in the possibility that the crash may self-reinforce and evolve into a tightening of crediting.
"Black Monday 1987" was replayed yesterday, with a crash in global financial markets and words like 'circuit breaker,' 'bear market,' and 'historic records' everywhere.
Both the Nikkei 225 and the TOPIX index have crashed by more than 12%, triggering multiple circuit breakers during trading. Taiwan Stock Market saw its largest percentage drop since 1967, South Korea saw its largest percentage drop since 2008, and the Dow Jones Industrial Average fell over a thousand points along with the S&P, marking the largest two-year drop. Fidelity and other institutions have issued warnings about trading failures.
The last time the global market suffered such a painful ordeal was the stock crash on October 19, 1987.
At that time, Asia-Pacific stock markets were in chaos, with the Nikkei index down 14.9%, the Hang Seng index plummeting more than 40%, and the New Zealand stock index even dropping as much as 60%. The US market was also in turmoil, with the Dow Jones plunging 22.6% and the S&P 500 falling 30% in a single day, wiping out around $1.71 trillion in the global stock market.
Apart from the similarities in the alarming degree of decline, the triggers for the two crashes were also similar - arbitrage and programmatic trading experienced a "big reversal." By taking a lesson from history, what will happen next? Will the Federal Reserve step in again to "rescue the market"?
"Black Monday 1987"
Looking back at the US stock market trends in 1987, on October 14th, the US government announced that the trade deficit was greater than expected, causing the dollar to depreciate and the market to fall.
On Friday, October 16th, the US House of Representatives issued a report to eliminate some tax advantages related to financing mergers and acquisitions. The decline in the US stock market worsened and it laid the groundwork for the turbulence that followed in the next week.
When it opened on Monday the 19th, people panicked to see that selling orders far outweighed buying orders in the market. Due to the huge difference, many market makers did not even provide market quotation in the first hour.
The US SEC later pointed out that as of 10:00, 95 S&P 500 constituent stocks were still not trading, while the Wall Street Journal reported that 11 of the 30 Dow Jones constituent stocks could not open for trading.
At the same time, as there was a considerable arbitrage space between stock index futures and stocks, a batch of trading institutions engaged in arbitrage trading, and as the stock market continued to plunge, a large number of hedging positions further shorted index futures in the stock index futures market, which in turn continued to push down the stock index.
At the close, the Dow Jones index plummeted by 22.76%, creating the largest drop since 1929.
Before the opening on Tuesday the 20th, the Federal Reserve issued a brief statement:
The Federal Reserve is committed to fulfilling its responsibilities as the central bank of the United States and to supporting economic and financial systems as a source of liquidity.
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Arbitrage and programmatic trading caused the sell-off
Like in 1987, the 'Black Monday' in 2024 was triggered by a perfect storm.
At that time, the US stock market had been in a bull market since 1982, and people thought it was time for an adjustment. The current AI boom has also made investors feel "chilly and forbearing."
The second similarity is the reverse of group trading. In the 1987 stock crash, "programmatic trading" was considered one of the culprits, as trading programs that held portfolios sold stocks, thus creating a domino effect.
And the recent stock market crash was partly due to the narrowing of the spread between US and Japanese interest rates, which triggered a 'reverse arbitrage trading.' The Bank of Japan unexpectedly raised interest rates last week, while the US Federal Reserve signaled rate cuts after its meeting last week, with the rate cuts almost fully priced in the market, and the most popular 'sell yen and buy USD' arbitrage trading in the foreign exchange market is no longer as appealing as before. Investors started to sell their USD assets for Japanese yen.
Meanwhile, in the week before the 1987 crash, there was also a 'Triple Witching Day' when stock option, stock index futures, and stock index option contracts all expired at the same time, causing serious instability in the final hours of trading on Friday and continuing the turmoil until the following Monday.
Finally, the analysis attributes this sharp decline to "collective hysteria", and each time the market plunges, investors' herd mentality exacerbates the decline.
Will the Federal Reserve intervene to "rescue the market" again?
Taking a historical lesson, what action will the Federal Reserve take?
In response to the market crash of 1987, the United States implemented an "emergency rate cut", established circuit breakers, and provided liquidity to rescue the market.
In order to decelerate the financial market downturn and prevent spillover effects on the real economy, the Federal Reserve quickly took action to provide liquidity to the financial system, injecting billions of dollars into the economy through quantitative easing policies.
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At the same time, Alan Greenspan, the then Federal Reserve chairman, announced an "emergency rate cut of 50 basis points", dropping the federal funds rate from over 7.5% on Monday to around 7% on Tuesday.
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In addition, regulators also introduced circuit breakers for the first time to prevent market crashes caused by programmatic trading. Once there is an abnormal decline or rise in the stock market, trading will immediately stop.
How will the big drop end?
Analysts believe that the worst-case scenario could be a repeat of 2008, but this seems unlikely. Although some large American banks collapsed last year due to betting errors on government bonds, banks' leverage ratios are much lower than before, and the impact of the liquidity crisis on the banking system is smaller because private credit now assumes most of the risks previously borne by banks. Huge losses are possible, and private funds may also run into trouble, but this will take time, and it will not trigger the same systemic crisis.
The ideal situation is that the excessive volatility of the stock market will gradually subside, as it did in 1987, without causing greater troubles. It is expected that this easing process will be slower than in 1987. The AI frenzy may cause stock prices to fall further, even though Nvidia's stock price has doubled this year despite a 30% drop from its peak in June. But the market is closer to normal levels, with the Nasdaq 100 index up only 6% so far this year, and the S&P index up less than 9%.
"Bond King" Yardeni believes that:
The danger of a market crash is that the plummet may self-intensify and evolve into a credit crunch. It can be imagined that this arbitrage trading closure may evolve into some kind of financial crisis, which in turn may lead to a recession.
However, he emphasized that he personally predicted that this result will not ultimately occur.
Editor/Emily