Hysteria fuels collapse of ’87

Like lemmings, investors swarmed over the precipice, pulling global stock markets into a crash the likes of which has never before been witnessed in financial history. Black Monday, as the investment community is labelling Oct 19, saw the largest stock market crash ever.

The destruction wreaked on the world equity markets was complete and thorough. On the New York Stock Exchange, the world’s largest and most powerful, the composite index plummeted at an unprecedented pace, giving up 508.32 pts or 22.62% of its value. More than $500 billion of value was erased. That fall, which eclipsed the 12.9% decline of Oct 28, 1929, underlies the seriousness of the collapse. In Toronto, the tse 300 composite index suffered its largest loss ever, crashing to 3,191.38 pts for a one day loss of 407.20 pts. Everywhere, traders and analysts were stunned by the fury and swiftness of the collapse.

“It’s unbelievable,” Paul Munger, a research analyst with Prudential Bache Securities, told The Northern Miner. “Nobody has ever seen anything like this.” Richard Nixon, assistant branch manager with Nesbitt Thomson Deacon Ltd., who has only been in the business for 2 1/2 years, handled the withering deluge of sell orders as well as most in the business. “We’ve seen mass hysteria on the downside and mass euphoria on the upside,” he said, commenting on the tse’s huge upside correction from the opening bell just two days after the crash. (See the Toronto Stock Exchange report on page 7).

The frenzied activity and uncertainty which raged during the day, spawned numerous rumors, all unfounded, of huge financial collapses. One of the wildest came from Tokyo, which said that Drexel Burnham Lambert Inc., one of Wall Street’s largest investment houses, had suffered immense losses. The rumor was quickly put to rest. “We hardly took a hit,” a Drexel spokesman told The Northern Miner. “Nothing is going to happen to us.” Gold, which is considered a haven during troubled times, soared on commodity exchanges by $11. Bullion peaked to $481(US) per oz. The following day, bullion dived to $465 per oz, underscoring vividly the intense volatility racking the markets.

The severity of the collapse has prompted many to look for similarities with the 1929 fiasco which ushered in the Great Depression of the early 1930s. Most observers see little likelihood that such a scenario will be repeated following the 1987 disaster. “I’m not concerned that we’ll turn to a deep recession,” Carl E. Beigie, chief economist and director of Dominion Securities Inc., told The Northern Miner. “The main change (of the collapse) will be to reduce the amount of growth.”

“The economy still has a considerable amount of momentum,” John Klinkard, senior economist with the Canadian Imperial Bank of Commerce adds. However, he cautions that a moderate recession could be in the offing shortly. “If we do enter a period of recession, it will not be totally unexpected. However, I don’t see the makings of a severe contraction,” such as that in the 1930s.

The selling mania which gripped the markets was also not totally unexpected. Since August, 1982, global exchanges have been enjoying a rollicking bull market trend fueled primarily by low inflation levels, low nominal interest rates and a relatively strong U.S. dollar. These underpinnings of the bull phase have, over the past year, begun to show signs of deterioration. Inflation fears have been increasing and interest rates have been on an uptrend — primarily in support of the weakening U.S. dollar. Inflation fears, rates fueled crash

The United States, whose dollar represents the world monetary system’s reserve currency, is also the world’s largest net debtor — a situation which has developed over the past five years as foreign capital has flowed into the U.S. Fears that a dollar crisis could trigger a massive outflow of capital from the U.S. are prompting the Federal Reserve Board in the U.S. to push interest rates up. These actions, in addition to worries over increasingly burdensome debt problems of less developed countries and, to a lesser extent, growing instability in the Persian Gulf, came to a head on Oct 19.

The end result has been a massive decline in investor confidence in the financial system. Doom and gloomers, such as American investment analyst Harry Schultz, have been predicting such a financial meltdown, as he calls it, for years. The market crash then, could be self-fulfilling, by ushering in some sort of recession, despite the fact that economic fundamentals remain healthy.

“The financial collapse will feed through to the economy quickly,” Francis A. Scotland, senior editor of the influential Bank Credit Analyst, explained to The Northern Miner. House prices in Toronto and Montreal, for example, are getting softer, he says. “A recession is around the corner. However, it is unlikely that we will get a depression like that of 1929-1933,” Mr Scotland says. Short-lived recession possible

The recession, however, will probably be short-lived, as government authorities will be forced to step in with monetary solutions to stimulate the economy. Classic economics notes that such a solution means only one thing — to inflate. “What choice do we have?” Mr Scotland queries. “You have to inflate.” Such monetary action would be achieved by massive injections of money into the system, thereby providing much needed liquidity, and drastically lower rates which would stimulate the economy. This, however, is perceived to be a mere bandaid solution to the real problems of massive deficit financings by world governments.

Days after the crash, government action was swift. The Federal Reserve Board in Washington reduced interest rates in the U.S., and in Canada several institutions also lowered rates marginally. Federal chairman Alan Greenspan gave notice, following pressure from financial markets to restore confidence, that Fed policy will now stress anti-recession, rather that anti-inflation just days before. “The Federal Reserve, consistent with its responsibilities as the nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system,” Mr Greenspan said. Bargain hunters swarm back

Combined with the appearance of bargain hunters on the scene, equity markets everywhere rebounded. At presstime, the tse composite index was up 290 pts with advances across the board. In New York, London and Tokyo, trading on the 20th and 21st saw advances. In Tokyo, approximately 50% of the exchange’s losses were recovered on Oct 22.

Most experts don’t expect a return to the heady days. But some semblance of market equilibrium is expected shortly. The general consensus is that the bull market has been put to rest — in convincing fashion.