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30 years on: How Black Monday stunned markets - and could it happen again?

(c) Sky News 2017: <a href="http://news.sky.com/story/30-years-on-how-black-monday-stunned-markets-and-could-it-happen-again-11087959">30 years on: How Black Monday stunned markets - and could it happen again?</a>
 

On this day, 30 years ago, stock markets around the world suffered a collective heart attack.

There have been plenty of grim times for markets since, such as the three years during which the FTSE 100 fell after the dot-com bubble burst, or the precipitous fall between late 2007 and early 2009 as the global financial crisis struck.

Yet "Black Monday", on the 19th October 1987, remains ingrained on the folk memory.

The 10.84% fall that the FTSE-100 suffered that day and the 12.22% fall it endured the following day remain the biggest one-day falls, in percentage terms, that the index has suffered in its 33-year history - far worse than any of the murderous one-day declines that the index suffered at the height of the financial crisis in 2008.

There are other reasons why the crash that day still looms large.

Many of the most senior people now working in financial markets were office juniors on Black Monday and had never seen anything like it, even though some of their older colleagues at the time would have remembered the brutal bear market of 1973-74 , during which the old FT-30 index lost almost three-quarters of its value after rampant oil prices tipped much of the world into recession.

The backdrop was also important in 1987.

Popular (NasdaqGS: BPOP - news) capitalism was enjoying its heyday, with share ownership soaring among ordinary Britons, following the privatisation of British Telecom, British Gas, Rolls-Royce and British Airways.

Interest in the stock market had never been higher and, for many first-time shareholders, Black Monday came as a considerable shock.

Then, of course, there was the weather.

The global market declines had actually begun the previous Friday 16 October, when Wall Street had sold off sharply.

However, due to the great storm, the London market had closed early as - with widespread road and rail stoppages due to fallen trees - many market participants had not been able to reach their offices in the City.

So Monday 19 October was the first opportunity for London to react to what had happened in New York the previous Friday and, with Far East (Kuala Lumpur: 5029.KL - news) markets also having sold off overnight, the sell-off was violent.

When Wall Street reopened, it too suffered another sharp decline, with the Dow Jones Industrial Average falling by 22% in a single session.

What caused Black Monday remains a matter of debate.

One of the big long-term factors that had supported the markets over the previous two years had been co-ordinated action by the world's biggest governments, the US, Japan, West Germany, Britain and France - this was before the collapse of Communism and the rise of China, of course - to bring down the value of the US dollar and then stabilise it.

This had sparked a US export boom and had been generally good for global growth.

However, by October 1987, co-ordinated action was coming to an end.

West Germany raised interest rates - this, of course, was a time before the euro - and Jim Baker, the US treasury secretary, had started to murmur that the dollar was again becoming over-valued.

All that led to unease.

On Wall Street, with the Dow having risen by 40% since the beginning of 1987, the ingredients were in place for a correction.

Many market professionals worry about the parallels between then and now.

As in 1987, stock markets have been buoyant for a number of years.

The bull market in US and UK equities has been running for more than eight years.

From the post-crisis low of 3,460.71 that it hit on 9 March 2009, the Footsie has risen by 117%, hitting a new all-time high several times this year.

The big three US stock indices - the Dow, the S&P 500 and the Nasdaq - have set numerous records this year.

So, too, has the Dax in Germany, while the Nikkei in Japan recently hit its highest level for 21 years.

There are also signs that the post-crisis co-ordinated action among central banks is coming to an end.

The US Federal Reserve raised its main policy rate in December 2015 and has since done so on three more occasions.

The Bank of England looks set to raise interest rates here for the first time since July 2007.

And even the European Central Bank, amid signs of a recovery in the Eurozone, may begin to tighten monetary policy.

The era of ultra-cheap money appears to be coming to an end.

At the same time, valuations - as measured by the traditional yardstick of the price-earnings (P/E) ratio - are high.

The S&P 500 is trading on a P/E of 25 - that is to say, if you bought the index today, it would take 25 years for you to get that money back through the earnings it pays out.

For most of the last half-century or so, the average has been closer to 15.

The FTSE 100, similarly, is trading on a higher than average P/E.

All of that makes investors uneasy.

To justify that kind of rating, company earnings have to be consistently high, yet there have been a number of companies that have recently disappointed investors with earnings that have come in below expectations.

These include Unilever (NYSE: UL - news) and Reckitt Benckiser (Xetra: A0M1W6 - news) , the consumer goods giants, both of which have generated excellent returns for investors in recent years - partly due to the globalisation phenomenon and the growth of the middle classes in emerging markets - but who are now finding the going somewhat tougher.

During the last week, no fewer than three FTSE 100 companies - the engineer GKN (Frankfurt: 694194 - news) , the medical equipment supplier Convatec and the theme parks operator Merlin Entertainments (Frankfurt: A1W713 - news) - have seen their shares fall by at least 10% in a single session after letting down investors.

And there is reason to suppose that, if there was another violent correction like Black Monday, it could be worse this time.

In 1987, most trading was still done by real people.

A lot of business was not done in 1987 because market-makers refused to pick up the phone to clients.

So people couldn't trade and so panic-selling was, to an extent, limited.

Now (Frankfurt: 11N.F - news) , in an era of high-speed trading and algorithms, there will always be a counter-party on the other side of a trade, should you wish to exit a position at whatever price you can.

That could exacerbate any panic-selling.

Moreover, there is less visibility in markets now, thanks to the rise of "dark pools" that allow large investors to trade in confidence and away from the prying eyes of the wider investment community.

That is not especially conducive to a transparent market.

But not everyone is worried.

The presence of circuit-breakers should, in theory, mean that any damage done by automated trading can be curtailed.

Nor is there as much leverage in the system as in 1987.

Investors are not trading using as much borrowed money as they were then.

Nor is there as much "euphoria" among investors as there was in 1987 or, for that matter, as there was in 1999 before the dot-com bubble burst.

This has been called the least-trusted bull market of all time, with many investors uneasy that it has gone on for so long, yet the market has had plenty of opportunities to sell off - the election of Donald Trump, the Brexit vote and so on - and has always subsequently rallied.

Yet, at some point in the future, there will be another stock market crash.

The law of averages tells you that.