Anatomy of The Stock Market Crashes of 1929 & 1987. Can It Happen Today?

Today is the 30th anniversary of the stock crash of 1987. All week long there has been a stream of recountings, anecdotes and comparisons to today’s market. While I love nostalgia as much as anyone, there are almost no valid comparisons to 1987 and it’s pretty much a waste of time to take that argument. Writers, analysts and investors who insist that stocks are about to crash like 1987 are either perma-bears who have been wrong for the past 8 years, people trying to make a PR splash or just plain ignorant.
Real crashes are generational events. They are market events, not economic ones. We saw one in 1929 and not again until 1987. 2008 was absolutely not a crash. It took weeks, months and quarters to unfold and it was very fundamental with the financial crisis. Flash crashes in 2010 and 2015 were definitely not stock market crashes. Remember, 1987 saw more than 22% cut from stocks in a single day and more than 30% from high to low.
True crashes don’t just come out of the blue and they do not occur from all-time highs. My basic study of crashes concludes that an asset literally melts up into a peak before the seeds of a crash can be sown. By melt up, I am talking about an historic rate of return over the past 6-12 months. Look below at what happened in 1986 and 1987. The Dow surged 50%+ in less than a year.
In 1928 and 1929 the rally was even more vertical as you can see below although it’s a little more difficult to make out.
Stock market crashes are also preceded by a repeating topping pattern where price melts up to the final high. After that, what’s viewed as a normal and healthy 10% correction sets in over the next month or so. Stocks find their footing and rally to a secondary peak which is lower than the all-time high. You can see this just above on the right side of the chart in 1929.
It is from this peak that the snowball begins to head downhill. Snowballs typically grow and grow as they accelerate more and more until they are at their largest the split second before they hit the bottom.
Today, we have absolutely nothing that resembles the price action of 1929 or 1987. It’s idiotic to even try and make that case. If stocks crashed like they did previously, we would be looking at a decline of thousands of points in a single day. Additionally, stock market participation was very narrow in the months leading up to the crashes in 1929 and 1987. The final advances were both led by very few stocks with the vast majority already experiencing double digit declines well before the decimation was even seen. That’s certainly not the case today as the NYSE Advance/Decline Line just hit yet another all-time high as you can see below.
Finally, although crashes are not fundamental economic events, there are certainly triggers and accelerators. In 1987, newly appointed and among the worst Fed chairs ever, Alan Greenspan decided to sharply raise interest rates to fight an inflation problem that didn’t exist. Additionally, Treasury Secretary, James Baker, engaged in a war of words with the Germans over their currency and even went so far as to threaten to devalue the U.S. dollar. Lastly, the strategy du jour, portfolio insurance, somehow seemed like this brilliant idea where portfolio managers would use computer programs to sell stocks the lower they went. And the lower they went, the more stocks were sold. And on and on and on. Talk about insanely ludicrous!
One day, the stock market will be set up again for another great crash. But first, investors who lived through the previous one will likely have to be no longer involved or represent a tiny minority. Those who ignore history are doomed to repeat it, or at least watch it rhyme.

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More on the Post Crash Pattern… Both Paths are Bullish

The only thing missing from a “perfect” pattern is for the S&P 500 to breach the August lows for up to a few days. I hesitate to use the word “perfect” because it rarely plays out exactly as I expect, but it certainly did so in 2011. Additionally, in both 1987 and 1989 which I partially dismissed, the final lows did not breach the crash lows before the big rally began.

As you can see from the chart above, I have two colored scenarios to the right of where the current price action ends. The light blue is the more immediately short-term bullish scenario and has the final bottom as being in and the rally beginning last week. The orange line is less short-term bullish as it has one more decline into the final low over the coming few weeks before blasting off to the upside.

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Follow Up to Post Crash Behavior

Last week, I wrote a piece here and in Street$marts entitled, Post Crash Behavior Leading to Dow 20,000. If you haven’t read it, I think it’s a worthwhile read (of course I do since I wrote it!) whether you agree with the content or not. Subsequently, I was really excited to join CNBC’s Fast Money to discuss my research. A few things I want to add.

I used the word “crash” very liberally in my study. After “bubble”, crash is probably the most overused word in investing. True, historic stock market crashes typically only occur once in an investing lifetime. They are such emotional affairs and require years of setting up. It’s that perfect storm. We saw one in 1929 as well as 1987. The rest are really just large declines that accelerated like a crash. You can call them crashettes or mini crashes.

As Mark Twain said a “few” years ago, history rhymes, it doesn’t repeat. No two market environments or rallies or corrections are exactly alike. The market does its best to confound the masses most of the time. I remember in 1998 that the NASDAQ 100 actually went from its August mini crash when Russia defaulted on her debt, straight back to all-time highs in September, only to see another mini crash in October when Long-Term Capital blew up. The masses were generally hopping on board the tech train until the tech wreck hit a few weeks later.

If you look closely at my study, 2011 looks very similar to 1998 and 1987 for the most part, but not exactly. 1989, 1994, 1997 and 2010 are not highly alike although 1989 and 1997 are the most alike of the group. 2015’s price decline is similar to 2010.

In the end, it’s much healthier for the stock market to thrash around for 4-6 weeks and test the mettle of both bull and bear. That kind of constructive repair from all the damage done during the decline would set the market up for a potentially powerful fourth quarter rally. I would be very concerned if stocks just took off higher from here without looking back.

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Don the Crash Helmets! It’s Bloody and Ugly Out There!!

By now, everyone knows that the Dow Jones Industrials fell by 1000 points last week, including a 531 point down day to close the week. More selling lies ahead in the short-term. It’s getting ugly. There’s blood in the streets. Sell what you can not what you want. Margin calls are coming. Maximum pain thresholds are being hit for the individual investor. Panic is here!

Before I opine on what it means, let’s put it all in perspective. 531 points is a 3% decline and 1000 points is just under 6%. Since the Dow peaked on May 19, the popular index has corrected 10% so far. In a worst case scenario, it could grow to 15-20% if China unravels beginning Sunday night.

For several months I have written many times about my concerns with the market. The most timely blog post was right at the most recent top on July 20.

Trouble Brewing Beneath the Surface

There were plenty of opportunities to take action, hedge, play some defense, sell, just do something proactive! I am sure that the vast majority of investors did absolutely nothing. In our portfolios, I am happy to report that we definitely took action several times by selling to raise cash as well as buying bonds which typically act as a flight to quality or “safe haven”.

I am not arrogant enough or naive enough to believe that during a full-fledged stock market correction that we won’t lose some money, but I am definitely pleased with our high levels of cash. This is a market time that separates the wheat from the chaff. The “pretenders” in the business get exposed. Investors don’t plan to fail. They fail to plan.

I often speak about the investing risk/reward ratio, referencing 18,500 on the upside and 16,900 on the downside. That negative skew caused us to take various defensive measures in many of our 12 strategies over the past few months. With the Dow finally closing below 17,000 with more downside to follow, the risk/reward is in the process of swinging firmly back to the positive side. It’s time to build a shopping list and prepare to deploy some of the beautiful cash that has built up.

Before I dive into the details of the stock market, I am going to start with my conclusion. While the evidence is certainly not as strong as it was a few months ago, I do not believe that the 6+ year bull market has ended; read, all-time highs lay ahead. The weakness looks like the first full-fledged correction since October 2011. The behavior we are currently seeing looks similar to what we actually saw in 2011, as you can see from the two charts below.

dia16 dia11

As I write this over the weekend and have not seen any stimulative action yet around the world, the preponderance of the evidence suggests that stocks are about to the enter the bottoming process, as soon as this week. While that doesn’t mean an immediate return to Dow 18,300, it does suggest that the repair process starts sooner than later, although high volatility won’t end soon.

From time to time as my great friend and colleague, Sam Jones, likes to say; Calling All Cars. It’s time add cash to your accounts. Blood is in the streets. Panic is setting in. It’s time to take on a little more risk or open a new strategy that’s more aggressive. That will likely be my theme for the next few weeks. On a personal level, I will be making my entire 2015 retirement plan contribution over the next few weeks so you truly know I how view the current situation.

If you have any questions about the market’s correction or your portfolio, please don’t hesitate to contact me directly by replying to this email or calling the office.

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Stock Market Groping for a Low

If you woke up this morning, turned on the computer or TV and saw another Texas healthcare worker with Ebola, European markets under siege yet again and our own stock market futures in collapse, you probably did not feel so great. Anxiety? Panic?

As the morning progressed and our stock market opened, your saw an immediate mini panic with the Dow down 370. At the same time, the 10 year treasury note’s yield absolutely and totally collapsed under 2%. That is capitulation in stocks and flight to quality or safety in bonds. Heading to the exits en mass. Throwing the baby out with the bathwater. Choose any cliche you want.

(Side note. Our Global Asset Allocation strategy has owned treasury bonds almost every day this year and today is the first time we are seeing a sell signal in that asset as its price has spiked to unsustainable levels.)

Is this “A” bottom or “THE” bottom or even a bottom. We should know more by the end of the day. If stocks rollover yet again during the afternoon and close below the lows of the morning, the panic is likely to follow through until we see another panic set up. If, however, stocks can hold the morning low and firm throughout the day, even to still close down, that would be a good sign that at least a bounce, if not full fledged rally is here.

The Russell 2000 index of small cap stocks, which has been bludgeoned since July has performed very well this week on a relative basis. And so far today with stocks taking it on the chin early, small caps fought back to unchanged. This is bullish behavior and not typically what we see if stocks were on the verge of additional collapse or even crash. It will be VERY telling to see how the Russell 2000 ends the day.

Besides the small cap stocks, Apple and Netflix have been pillars of relative strength of late. When stocks finally bottom and bounce, I would closely watch these two large caps for leadership.

On the sector front, none have been spared the carnage of the last month with energy being decimated the most, close to the point where they have performed so poorly, it’s actually good going forward. I remain positive on REITs, biotech, transports and semiconductors for now, but that should change with the heightened volatility from day to day and week to week.

I fully expect wild swings today and probably the rest of the week.

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Who Turned the Lights Out… Again

¬†Yesterday, I wanted to see what leadership emerged after Wednesday’s big surge and more importantly, I wanted definite confirmation from the plan vanilla high yield (junk) bond mutual funds that the canary wasn’t dying. That was before the open.

I have to say that the depth and tenaciousness of Thursday’s decline definitely caught me off guard. While giving back 25% or even 50% of the big rally would not have out of the ordinary, losing all of it certainly was. It reminded me of January 2008 as stocks were groping for their first low of the year.

The anticipated up day in plain vanilla high yield bond funded ended up as a moderately lower day in the end. That is not good. It says that liquidity is leaving the market and shows concern that the economy may not be as stable and strong as the jobs report indicated. At this point, high yield bonds look like they want to continue lower as water finds its own level. The positive from my selfish perspective is that there should be a very solid buying opportunity over the coming month for a good trade into the New Year. I can’t believe I just typed “New Year.” Wow, did this year fly by!

Looking at the stock market, earlier this week I wrote that there was a 15% chance of a 8-11% correction taking the Dow below 16,000. That scenario certainly looks like it’s shaping up. With the August lows in the S&P 400 and Russell 2000 long breached, the S&P 500, Dow and Nasdaq 100 should not be too far behind.

Given the depth of the pullback, a scenario should unfold where stocks see some capitulatory selling next week or soon thereafter followed by a feeble rally and final decline into the ultimate bottom. I will discuss more if and when this unfolds. For now, it’s probably too late to sell and too early to buy. Patience is the virtue.

Have a safe and enjoyable weekend, especially if it’s a long one for you! I would be surprised if the media doesn’t start talking correction, crash, etc. with possible Blue Monday.

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U-G-L-Y Day on Thursday

The stock market had a very rough day on Thursday with all of the major indices breaking down below all short-term support levels for the chartists out there. There is no other way to characterize than UGLY. Keep in mind, however, that so far, all we have seen are 3-6% declines. It feels much worse because we saw two large down days over the past week, the likes of which we haven’t seen all year, including the January pullback.

On the sector front, all of the old leaders have taken it on the chin and have been in gear to the downside. New leadership has emerged from REITs, utilities and staples with energy, industrials and materials hanging in impressively so far. This continues to look like the market rotating to the next and perhaps final stage in the five plus year old bull market.

I haven’t said this in a long time,¬† but Friday is a “key” for stocks. Early weakness is better than strength as long as selling does not accelerate during the day. If we see a weak opening that firms during the day, that will go a long way to stemming the tide for the bulls and setting up a potential bounce next week. On the flip side, another day of torrential selling sets up some rather nasty and dark scenarios…

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