MARKET COMMENT
Lessons From Black Monday

By Maynard Paton (TMFMayn)
October 18, 2002

It was the day the filofaxes fell apart, the red braces snapped and the champagne went flat. October 19th 1987. Black Monday.

To recap, it was the day when global stock markets suddenly crashed. The Dow Jones plunged 22.6% to 1,738, while the FTSE 100 plummeted 10.8% to 2,052 on the Monday and another 12.2% to 1,802 on the Tuesday. What exactly triggered the panic selling has never been exactly clear. But the reasons probably include a rise in German interest rates, a US attack on an Iranian oil platform and the snowball effect of rather unsophisticated "portfolio insurance" systems (i.e. stop-loss systems) adopted by many institutional investors. Bad weather didn't help UK investors either. The 'Great Storm' put the London Stock Exchange (LSE: LSE) and most of the South East of England out of action on the preceding Friday.

Anyway, the actual causes for the crash aren't important. What is important is learning the investment lessons.

Firstly, the opening six months of 1987 saw a thirst for new issues. With growth in consumer spending at a then all time high, specialist retailers were the stock market vogue. For instance, the flotations of Sock Shop and Tie Rack were 53 and 80 times oversubscribed respectively.

Also taking investors' fancies in 1987 were "shells", tiny quoted companies whose only worthwhile asset was a stock market listing. Such was the speculative fever at the time, any 'entrepreneur' could take control of a shell, announce some wonderful business plan and see the shares promptly soar. Anybody remember Peek Holdings? During the heady summer of 1987, it announced a rights issue at 2.5p per share to help fund its transformation into a leading electronics firm. Its shares quickly shot up to 160p.

All sounds a bit familiar, doesn't it? For Sock Shop and Peek Holdings, read Lastminute.com (LSE: LMC) and Knutsford. Just as the TMT bubble also showed, when new issues and penny share dross are in high demand, it essentially means everybody has already filled their boots with all the other available shares. And as such, there are few shares left to buy...

Another lesson to take from Black Monday is to think long term. Sure, a 20% drop in one day isn't pleasant. But don't forget the FTSE 100 rose 45% during the first seven months of 1987 and actually ended the year 2% higher. So look at the second chart on this page. Can you spot Black Monday? On a 20-year timescale, you can see how the ups and downs of 1987 were just a blip on an index tracker's rising path.

And the final lesson from Black Monday is this: it made for a great buying opportunity. Rather than suddenly think shares were no longer suitable as an investment, prudent investors should have been busy placing all their savings on the stock market. After the last panic-stricken investor finally dumped his shares on November 11th 1987, the FTSE 100 never looked back.

A version of this article was first published in October 2001