From: University of Illinois
Published October 16, 2007 06:35 PM

'Black Monday' anniversary a reminder of stock market's inherent risks

CHAMPAIGN, Ill. — The 20th anniversary of Wall Street’s historic “Black Monday” collapse is a good reminder that the lure of investment riches comes with equally dramatic risks, a University of Illinois stock market expert says.

“Events like this remind us that markets have risks and that investors need to exercise prudence. It reminds us that markets are volatile by nature and to respect that,” said David Ikenberry, the chairman of the finance department.

Jittery investors triggered a massive sell-off on Oct. 19, 1987, driving the Dow Jones Industrial Average down more than 22 percent – the second-largest one-day percentage decline in history. The 508-point slide, dubbed “Black Monday,” wiped out about $560 billion in market worth.

Financial markets are never immune from freefalls, Ikenberry says, but he doubts a repeat anytime soon despite concerns about a credit crunch and housing glut that have hovered over Wall Street this year.

“Any time where there is a potential for a run on the bank, you have the potential for a dramatic downturn. But I don’t see such an event like ‘Black Monday’ on the horizon. There are no warning lights flashing,” said Ikenberry, whose research includes long-horizon stock returns and stock-repurchase programs.

The steepest market declines have often occurred in periods of time when relative stock prices were inflated, Ikenberry said. The “Black Monday” slide followed one the market’s longest and strongest advances in history, fueled in part by rapid expansion of mutual funds and 401(k) retirement plans.  Moreover, relative price per share of stocks was much higher compared with today.
“We’re not in one of those periods now,” Ikenberry said. “The market in relative terms does not appear to be so overvalued, and as such downside exposure is seemingly not as great as say in 1987.”

Two decades later, debate still swirls about the exact cause of the near-record crash since there were no major events or economic news beforehand to trigger a panic.

Ikenberry says a host of factors may have contributed. The market underperformed the Thursday and Friday before “Black Monday,” he said, a sign that fund managers as well as individual investors may have set up the sell-off after stewing over the weekend.

So-called “portfolio insurance” offered in the 1980s also could have played a role, Ikenberry said. He says the insurance was actually a trading strategy that shifted more assets to bonds as stock prices fell, creating a domino effect once the sell off began.

“To effect that coverage, it required selling off a huge volume of stocks, which just exacerbated the problem,” Ikenberry said. “What started off as a flicker of a flame turned into a bonfire.”

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