Is the stock market’s seemingly relentless 2017 rally anything like the 1987 run-up that ended 30 years ago Thursday with the most devastating one-day plunge in Wall Street history?
At first glance, investors might think so. And charts arguing the case have made the rounds from time to time. But on closer examination, many of those comparisons don’t hold water.
Here’s a look at a pair of charts from LPL Financial that illustrate the point.
The S&P 500 SPX, -0.09% chart above, which resembles overlays that have circulated on social media, looks a bit ominous. But as strategists John Lynch and Jeffrey Buchbinder point out in a note, the comparisons are misleading. The 100-point increase in the 1980s on the right scale is a much bigger percentage rise than the roughly 450-point rise on the left.
When 1987 is compared with 2017 using percentage gains, the current rally pales in intensity, they note, while also using a three-year window to strengthen the point:
“From the start of 1985 through the 1987 peak, the S&P 500 more than doubled in price (a greater than 100% gain). Over an equivalent time period today (the start of 2015 through the 2017 peak), the S&P 500 is up 24%,” Lynch and Buchbinder wrote. “Stocks were a lot more stretched back then, making a sharp move lower more likely.”
The S&P 500 ended Black Monday with a decline of more than 20%—a similar move would knock more than 500 points off the index at current levels. The Dow Jones Industrial Average DJIA, -0.08% plunged 508 points, or nearly 23%. In current terms, a fall of the same magnitude would knock the Dow down by more than 5,000 points.
While stocks don’t appear to be as stretched as they were in 1987, analysts do argue a pullback may be overdue. The S&P 500 has gone 240 trading days without a one-day drawdown of 3% or more—just a day shy of the record of 241 days in 1995-96.
Sam Stovall, chief investment strategist at CFRA, noted that today’s bull market—the second longest on record—is 103 months old versus the 60-month duration of the 1982-87 bull that ended on Black Monday. More important, while 12-month earnings growth through the second quarter of 2017 was 121% versus 17% in 1987, the trailing 12-month price-to-earnings ratio for the S&P 500 is 23.5, versus 20.3 in 1987. Also, he noted, the dividend yield was more attractive in 1987 at 2.7% versus 2% now (see table below).
But all in all, history indicates a comparison with 1987 isn’t warranted, he agreed.
While the stock market this year has enjoyed a slow, steady, low-volatility advance and continues to notch record after record. In 1987, the S&P 500 peaked around two months ahead of the Oct. 19 crash, Stovall said, noting the S&P 500 had also declined by more than 16% through Friday, Oct. 16, from its Aug. 25, 1987 high, which should have rang some alarm bells.
“Ultimately, when comparing today’s fundamental foundations with those from 1987, one will quickly conclude that there are very few similarities between then and now,” Stovall said.
Market structure concerns
So nothing to worry about, right?
Not necessarily. The 1987 crash, while preceded by a frothy performance, is seen in large part as a failure of market structure. The interplay between the rise of computer-driven trading and the use of portfolio insurance, a strategy that prompted the increased selling of stocks and stock-index futures as declines mounted; arbitrage between stock-index futures and stocks; and the inability of some specialists to fulfill their duty to provide liquidity, share the blame in many accounts of Black Monday.
“While portfolio insurance doesn’t carry the same clout today as it did in 1987, short volatility strategies are equally pro-cyclical in nature with unlimited exposure, ETF volumes dwarf single stock volumes creating distortions in fast markets, while [high-frequency] trading has already shown its preference for finding foxholes versus fighting when markets trade outside their log-normal models,” wrote Jeffrey deGraaf, chairman of Renaissance Macro Research, in a Wednesday note.
DeGraaf isn’t calling for a crash soon. He’s argued that stocks could be setting the stage for a “melt-up,” in which investors fearful of missing out on a rally stampede into the market and drive a surge. But he and other market veterans have expressed concerns about a more complex and untested market structure.
“These are different flavors, but similar in their spirit to the problems that plagued markets 30 years ago,” he said. “Our money is on the next crisis looking more like 1987 than 2008.”
The 1987 bounceback
Meanwhile, Stovall makes the case that even in the event of a similar plunge, there would be comfort to be taken by looking back at the 1987 drop.
While the S&P 500 dropped more than 20% on Black Monday—a plunge that would take more than 500 points off the index at current levels—on its way to a peak-to-trough decline of 33.5%, the move took only 101 calendar days, versus the average 419 it took to complete the 12 bear markets seen since 1946, he said. And while the 1987 total decline was pretty much equal to the average drop for all bear markets, it took 154 fewer days to get back to break-even than the average.
“Like ripping off a Band-Aid, the experience offered by this unpleasant market shock indicates that a future market crash may also conclude and recover much more quickly than a slower, more deliberate, bear market,” he said.