The Market Today: Shades of 1987?

Posted by Brad McMillan, CFA, CAIA, MAI

This entry was posted on Oct 13, 2016 1:56:34 PM

and tagged Commentary

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the marketIn the past couple of days, three different people have forwarded me an opinion piece that attempts to draw some parallels between the way the market acted in October 1987—before the infamous Black Mondayand the way it’s acting now. Some analysts are actually issuing alerts that we might get a significant pullback.

I reviewed the charts, which do look quite similar. And the stock market is indeed showing signs of weakness. Since the S&P 500's most recent peak—at 2,175.30 on September 30—we have dropped a bit over 2.6 percent as I write this. Worse, the market has broken through the 100-day moving average. Is doom ahead?

In a word, no. That’s not to say we won’t see a deeper pullback; we might. But the underlying conditions remain positive for both the economy and the stock market.

We’ve seen this type of thing before, remember?

We could compare right now to June of this year, when markets dropped more than 5 percent and broke the 100-day line, or last December to January, when markets fell nearly 12 percent, breaking the 200-day line. As those drops show, a pullback doesn’t necessarily mean a bear market. In fact, in both cases, the pullback set the stage for a stronger move up. Even after the 1987 decline, as terrifying as it was, the market returned to new highs within a year.

Pullbacks are normal. Big drops are less normal, but still not uncommon. When I see calls for a 1987-type event, I draw two conclusions:

  • First, markets are still worrying, which is actually a good sign.
  • Second, because of that worry, a long-term pullback is much less likely.

Since 1929, we have had 10 bear markets, with a decline of 20 percent or more, and several other close calls, such as 1998 or 2011, where markets were down almost that far. In all of the bear market cases except two, the economy was in a recession before the bear market kicked off. In the two cases without a recession (1962 and 1987), the market did decline sharply but then bounced back within a year.

In other words, without a recession, pullbacks may be large but they haven’t been long.

Keeping normal pullbacks in perspective

When most people hear 1987, they think “major market event that could wreck my portfolio.” In fact, 1987 was not that event. 2000 and 2008, if handled improperly, could have wrecked portfolios, but that was because they combined a large decline with a long-term recovery. A shorter-term pullback is much less damaging, even if it’s every bit as scary at the moment.

As I have written before, I do not see a recession any time soon, so I’m not concerned about a sustained bear market just yet. That said, I wouldn't be surprised if we get more market volatility, including a larger pullback. With all of the uncertainty around the election, along with potentially growing problems elsewhere in the world, it’s certainly possible.

I personally start to pay attention when the market drops below its 200-day moving average. For the S&P 500, that would be around 2,068, which equates to a drop of just under 6 percent from the all-time high. This kind of a dip would be absolutely normal volatility—and something that, again, we’ve already seen twice this year. However similar the charts look, what we are seeing now is pretty normal, not a signpost of doom.

If we do get a repeat of 1987, that would be scary and damaging. On the other hand, it would also likely be short lived and a buying opportunity—or, in other words, a pullback. Right now, economic conditions are such that any drop is very likely to be just that rather than something worse.

Let’s not confuse a pullback, even a very big one, with another 2008.

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