On Oct. 19, 1987, the Dow Jones Industrial Index plummeted 22.6% in what would later become known as Black Monday. The causes of the crash are still debated to this day, but the severity of its impact is not. Stock market losses in October hit $1.7 trillion globally as 19 out of the 23 major markets experienced drops of over 20% for the month.
Now, Albert Edwards, a global strategist at the French investment bank Société Générale, is worried history may repeat itself. The stock market’s strength in 2023 despite the economy-slowing effects of higher interest rates is a combination that feels awfully familiar to the days when Ronald Reagan was president, the typically bearish and often sardonic strategist warns.
As the lure of safe returns grows with every jump in Treasury yields, pulling investors away from the riskier stock market, Edwards is hearing “echoes of the 1987 crash.”
“The equity market’s current resilience in the face of rising bond yields reminds me very much of events in 1987, when equity investors’ bullishness was eventually squashed,” he explained in a Tuesday note. “As U.S. bond yields surge ever higher, do you feel like you are in a car you just know is about to crash but are powerless to stop?”
Edwards said that “increasing uncertainty” about the future of the U.S. economy amid rising interest rates coupled with “fiscal dysentery”—a crude reference to the record budget deficits and political gridlock in Washington that have nearly led to multiple government shutdowns—have helped drive the 10-year Treasury yield over 4.7%. Essentially, investors now require more compensation for the increased unpredictability of holding longer-term debt.
“Never in my career have I witnessed such uncertainty about where we are in the economic cycle. Is that long promised recession still lurking around the corner or are we at the start of a new economic cycle? Many investors are apparently increasingly convinced it’s the latter,” Edwards wrote. “My own view is that a recession still lurks.”
The strategist believes that there is “still plenty of evidence to suggest a recession is imminent,” warning that “just like in 1987, any hint of recession now would surely be a devastating blow to equities,” which are priced for a soft landing scenario in which the economy recovers from its current turbulence without a significant increase in unemployment.
He pointed to the recent drop in trucking jobs, arguing it “typically signals a recession is dead ahead,” as well as the ongoing surge in corporate bankruptcies and the contracting money supply.
Citing a fellow bearish economist, David Rosenberg, Edwards also noted that recent revisions to the second quarter GDP report showed that Gross Domestic Income (GDI) growth—a measure of economic activity that is often used as a proxy for Americans’ “earnings”—hasn’t been nearly as robust as imagined. When you account for inflation, so-called real GDI growth fell to just 0.2% year-over-year in the second quarter.
“The trend has never been this low, not ever, without a recession taking hold. The ‘soft landing’ is over,” Rosenberg wrote of the data in a recent note. To which Edwards added in a rebuke of his bullish critics: “Put that in your pipe and smoke it.”
While Edwards fears a repeat of Black Monday, the causes of that crash are still widely debated and the two periods aren’t exactly the same. It’s true that through the first seven months of this year and in 1987, both interest rates and stock prices rose in unison, but the lead up to that dynamic 35 years ago was very different from what has happened in recent years.
After years of rampant inflation in the ‘70s, then Fed Chairman Paul Volcker hiked interest rates to a peak of around 19% in early 1981. Then, with inflation slowly fading, he cut rates to just 5.9% by September 1986. This led to the Dow Jones to soar 250%, from 776 to 2722, between August 1982 and its peak in the same month in 1987.
The end of that run is the period that Edwards believes is so similar to today. Between September 1986 and October 1987, interest rates rose from 5.9% to 7.3%. But over roughly the same period, the Dow Jones Industrial Average continued its rise, jumping 45%, as investors retained their bullish outlooks after years of gains. That was before it all came crashing down on Black Monday.
Similarly, this year, interest rates have jumped, but so has the market as many investors remain bullish, and that gives Edwards pause.
Still, some traders have blamed Black Monday on newly implemented computerized trading programs that were programmed to sell stocks automatically when major indexes fell. And others have even blamed tax changes that would have made corporate takeovers, which had begun incredibly common in the ‘80s, more costly.
Yale economics professor and Nobel Prize winner Robert Shiller also found in a 1987 survey of both institutional and individual investors that a general “crash mentality” had developed in the U.S. at the time due to fears of high stock market valuations, rising private and public debts, the declining strength of the dollar, and the potential negative effects of the birth of “portfolio insurance”—the hedging of market risk, typically via the short-selling of futures for stock market indexes. And not all of these risks are relevant now.
Still, Shiller warned in a 2017 New York Times op-ed that a similar crash mentality and subsequent panic could happen again, especially if interest rates rise quickly, noting that investor psychology never truly changes. Edwards fears that day may come sooner rather than later as the Fed continues its fight against inflation. At this point, as he says, maybe “all you can do is brace yourself and hope for the best.”
The good news? The after effects of Black Monday were somewhat limited economically, partly due to government and central bank intervention. The U.S. didn’t fall into a true recession until 1990 after the savings and loans crisis rocked the financial industry and the Persian Gulf crisis caused oil prices to spike. By that time, the stock market had recovered, jumping 40% from its November 1987 low.