Fidelity: What have we learnt 30 years on from Black Monday?
This Thursday marks the 30 year anniversary of Black Monday, when 30 years ago stock markets around the world crashed and investors were faced with a shocking new reality. But what caused the crash and most importantly, have we learnt from our mistakes?
- What happened?
Chart 1: US investors saw losses of around 10% in just two weeks
Source: Datastream, October 2017. Indices rebased to 100 from 15 October 1987
During the crash of ‘87, US investors saw losses of c. 10% in just two weeks. But what was to blame? Black Monday was the first market crash to be blamed on automatic trading programmes. Programmatic traders essentially relied on selling stocks as they fell, thus limiting the damage to their own portfolios. But when everybody sold, it drove the market to crash more.
- Could this happen again?
Chart 2: Rules based trading has been blamed more recently too, such as in 2010, when the S&P 500 fell by around 6% in just twenty minutes
Source: Bloomberg, October 2017
Programmatic or rules based trading have been blamed for other crashes, most notably the 2010 flash crash, when the S&P 500 lost 6% in just twenty minutes. Since 1987, quants have almost doubled their share of all US stocks trades from 13% to 27% in 2017, potentially increasing the chances of a quant driven crash in markets.
- But prolonged falls tend to be caused by a deterioration in conditions
Chart 3: Impact of China’s devaluation of the renminbi in 2015
Source: Datastream, October 2017
It’s worth bearing in mind that if the market sells off for a prolonged period, that needs to be driven by a deterioration in conditions. It took 18 months for the S&P 500 to recover its losses after Black Monday in 1987. But markets recovered much quicker from the volatility seen in August 2015 and early 2016 in China, as it became clear that Chinese and global growth were healthier than markets realised.
- Tune out the noise and focus on the long term
Chart 4: All but two of the ten worst monthly drawdowns in the S&P 500 have seen strong returns over the subsequent decade
Source: Datastream, October 2017
The most important thing to remember is that equity markets offer good returns over the long term. The worst monthly drawdowns over the past forty years have usually been followed by strong returns. On average, investors can earn around 7% per annum from equities.
However, lessons can still been learnt and areas of caution going forward are warranted. For example, Black Monday highlighted how important market structure is. With this in mind, low volatility strategies may be a cause for concern, crowding into low volatility stocks, only to suffer losses when volatility rises.
There are also concerns over fixed income markets. Passive strategies have strict rules around how they track an index, and can become forced sellers if an investment grade bond is downgraded to high yield status. Since 2009, the number of investment grade bonds on the borderline of high yield classification has tripled, meaning a bigger proportion of many investment grades indices could be downgraded. That could exacerbate the impact of any future crisis.
- Searching for value: financials and energy
Chart 5: Energy and financial sectors have underperformed the broader market
Source: Datastream, October 2017
That said, investors should not just sit back and do nothing. Tactically allocating across markets can help to protect investors from prolonged drawdowns and market changes. Financials, for example, remain attractively valued compared to the wider market, and offer protection against higher interest rates and a steepening in yield curves. Energy equities are one of the few sectors to have actually lost money this year, despite fundamental improvements in the oil price continuing to come through. Indeed, some oil companies are generating more cash now with oil at $55 per barrel, than they were when oil was at $100.
James Bateman, CIO, Multi Asset at Fidelity International
