For those of us who were watching that day, October 19, 1987 is forever seared into the memory banks. One doesn’t easily forget a 20% correction in the stock market that arrived in a matter of hours.
This reporter, working at a small trade magazine at the time, remembers the day vividly. The daily routine at the office began as usual, but as the morning gave way to afternoon all ears turned to the radio (the medium of choice for breaking news in those days). By 2 p.m, no one was working; all gathered in the conference room, listening to the updates on the spectacular collapse in stock prices. The selling grew more intense as the minutes ticked by. By the close of trading, we could only guess at what a 20% drop meant for the weeks and months ahead.
The obvious analogy was the crash of 1929 and the Great Depression that followed. Would history repeat itself in 1987 and beyond? Fortunately, the answer was “no.” The massive selling of October 19, 1987 was an isolated event, virtually unrelated to the economy. The Federal Reserve played a pivotal role in stopping the chaos in the market from infecting the general economy. Rather than squeezing credit supply, as the central bank did in the early 1930s, the Fed learned its lesson and instead pumped huge amounts of liquidity into the system in the days and weeks after the ’87 crash. By most accounts, that timely act was crucial in containing the carnage.
Twenty years on, what have we learned as investors? Buy on the dips. That has become the mantra for many, and the lesson was forged in 1987 and several times since. The latest example has come in the last several months. Reacting to the subprime woes of August, Bernanke and company dispatched an aggressive 50-basis-point cut in interest rates last month. The medicine worked its magic once again. The late-summer correction in U.S. stocks has since reversed, and the Fed’s timely injection of liquidity has figured prominently in the renaissance.