In the run up to the 1987 stock market crash, from 1981 to 1986, US equities and bonds went on a tear on the back of sharply falling interest rates. Federal Reserve Chairman Paul Volcker had successfully tamed inflation by ratcheting up the Fed Funds rate from 4.7% in February 1977 to 19.1% in July 1981. Once inflation was brought under control, Volcker dropped the Fed Funds rate all the way back to 5.9% by October 1986. Cheap stocks and plunging yields led to a surge in equity prices. The S&P 500 rallied +237% from 1982 to 1987.
The sharp fall in yields was not all positive. The US dollar, having rallied with US equities and bonds from 1981 to 1985, started to drop in 1985. The decline accelerated lower over the next two years and the USD ended up losing -42% of its value from 1985 to 1987. The combination of an overvalued stock market, overly bullish investor sentiment, a collapsing currency and automatic trading programmes in place at the time resulted in the panic now known as Black Monday. Next, I will look at the set up in markets today to compare the similarities.
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