There has been increasing chatter in the financial press in recent months of an impending stock market accident. So today, let's take a look at what happened in the run up to the 1987 crash to see if there are any similarities. From 1981 to 1986, US equities and bonds went on a tear on the back of sharply falling interest rates in the US. Fed Chairman Paul Volcker had successfully tamed inflation by driving the Fed Funds rate up from 4.7% in February 1977 all the way 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 week, I will look at the current set up in markets to identify the key similarities and differences.
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