Two numbers mesmerized stock investors this week: 23,000, the latest milestone the Dow Jones Industrial Average surpassed, and 1987, the year of the biggest one-day crash in stock market history, whose 30th anniversary we commemorated Thursday.
(Another big number that got investors’ attention: 51-49, the Senate vote that approved the new federal budget, a necessary step to achieve tax reform, whose prospects appear to be the main reason stocks continue to rise.)
Dow 23,000 symbolizes a bull market that even after 8 ½ years doesn’t look tired. October 19, 1987 was a stark warning of what can happen when markets have gone too far and investors get too complacent.
As I wrote in my MarketWatch column this week, the crash of 1987 was the culmination of nearly two months of market turmoil. Stocks actually peaked on August 25, 1987, and the week before Black Monday was the worst ever.
On Friday, October 16, 1987 the Dow racked up a 4.6%, 100-point-plus one-day loss, which set a record, too. But nothing prepared investors for Black Monday’s 508-point, 22.6% decline.
So, what does it have to do with us today?
First of all, when it peaked in August, the Dow had gained 40% in 1987 alone and 250% in the five years since the bull market began in August 1982.
This time around, the Dow has rallied 28% since the day before Election Day and 256% since this bull market started in March 2009.
Then, stocks moved higher as the economy recovered from a deep recession and rallied as the Federal Reserve cut rates and the Reagan Administration reduced regulation and did real tax reform.
Now, the Fed has kept rates low for a long time and has raised them very, very slowly, while the Trump Administration has slashed mostly environmental regulations and pushed aggressive tax cuts for business.
Then, program trading in the form of “portfolio insurance” and index arbitrage were huge factors. Now, algorithmic trading is dominant and the rise of passive investing and exchange-traded funds (ETFs) would pose unknown risks in a selling panic.
There’s one huge difference: In 1987, President Reagan and Soviet leader Mikhail Gorbachev signed a landmark agreement to reduce intermediate-range nuclear missiles, greatly lowering tensions. Now, President Trump and North Korean leader Kim Jong un are in a war of words and nuclear threats that has escalated global tension.
This week, Treasury Secretary Steven Mnuchin said if Congress doesn’t pass tax reform, stocks could have a “significant” drop, while former CIA director John Brennan put the risk of war with North Korea at 25%.
As of now, those political factors have the best chance of making the Dow fall far below 23,000 in a selloff like that of 1987, and that’s why risk is a lot higher than it looks.