Image Source: Pixabay

The stock market has experienced several ups and downs over the years, each with its own particular set of consequences. “Black Monday,” a historic stock market catastrophe that occurred in 1987, sent shockwaves throughout the finance world.

Fast forward to 2023, and the market is once again in a volatile and unstable condition. Interestingly, there are striking similarities between the occurrences in 1987 and the status of the stock market now. Some significant parallels between these two eras include the following.

Economic Expansion Preceding the Crashes

One of the most significant parallels between 1987 and 2023 is the economic backdrop leading up to the crashes. In both cases, there was a period of economic expansion and prosperity. In 1987, the United States enjoyed several years of robust economic growth after dealing with concerns about inflation and trade imbalances.

A similar situation exists in 2023, with global economies recovering from the challenges posed by the COVID-19 pandemic, supply chain disruptions, and geopolitical tensions. The buoyant economic conditions contributed to a sense of optimism that, in hindsight, might have been overly optimistic.

Overvaluation of Stocks

In 1987, stock prices were driven to unsustainable levels, with the price-to-earnings (P/E) ratios of many companies reaching historic highs. Similarly, 2023 has seen the stock market’s valuation stretched, with P/E ratios at levels that are cause for concern. Such elevated valuations can create a sense of vulnerability in the markets, with investors worrying about a potential correction as such high valuations may not accurately reflect a company’s underlying fundamentals.

Rapid Technological Advancements

The years 1987 and 2023 were both marked by significant technological advancements, which played a role in shaping market dynamics. In the late 1980s, the financial industry was in the midst of a technological revolution with the introduction of computer-based trading systems, which contributed to the rapid pace of trading and market volatility.

Today, we are experiencing a similar trend with algorithmic trading, high-frequency trading, and the use of artificial intelligence in investment strategies. These technological advancements can amplify market moves, making it important for investors to adapt to the changing landscape, just as computer-based trading had a significant impact in 1987.

Geopolitical Factors

Geopolitical factors have played a significant role in both the 1987 and 2023 stock markets. In 1987, concerns about US-Soviet relations and the Iran-Iraq war contributed to market jitters. In 2023, geopolitical tensions involving Israel-Hamas, US-China, and Russia-Ukraine will continue to influence market sentiment. Geopolitical events can trigger sharp market moves and require investors to stay vigilant.

Deteriorating Market Sentiment

Leading up to the crashes of 1987 and 2023, there was a growing sense of unease in the markets. Investors were becoming increasingly nervous about the sustainability of the bull markets. In both cases, there were signs of deteriorating market sentiment, including increased volatility and uncertainty. This negative sentiment can create a self-fulfilling prophecy, as anxious investors may rush to sell their holdings, further driving down stock prices.

Lack of Liquidity During the Crash

In 1987, the widespread use of portfolio insurance strategies led to a liquidity crunch when the market started to decline rapidly, while in 2023, the concern centers around liquidity in the bond market, especially given the potential for rising interest rates. In both instances, trading came to a near standstill as panic selling overwhelmed the market. The absence of buyers exacerbated the sharp declines in stock prices.

“Flash Crash” Phenomenon

The concept of a “flash crash” was virtually unknown in 1987, but it has become a recurrent theme in the modern financial landscape. A flash crash is characterized by a rapid and severe drop in stock prices and is often followed by a swift rebound.

Such a phenomenon is driven by factors like algorithmic trading and high-frequency trading. Both 1987 and 2023 have witnessed the rise of algorithmic trading. These days, high-frequency trading and algorithmic strategies dominate market activity, making the markets more susceptible to rapid price swings.

Regulatory Responses

A regulatory response was required in both 1987 and 2023 in order to address the vulnerabilities the market crashes had revealed. The US government enacted measures to promote market stability, including circuit breakers, in the wake of the 1987 Black Monday to avert high volatility and a collapse of a similar scale.

In 2023, the impact of high-frequency trading is being addressed, and market resilience is being improved, according to regulatory organizations’ 2023 plans. The importance of effective regulation in maintaining market stability cannot be overstated.

Financial Innovation

Financial innovation has been a common theme between the events of 1987 and 2023. Similar to how the creation of new financial products like stock index futures and options contributed to the market crash in 1987, innovations like decentralized finance (DeFi) and digital assets are anticipated to completely transform the financial environment in 2023. Investors may face new risks and opportunities as a result of such financial innovation.

The Role of Psychological Factors

In 1987, investor sentiment was excessively bullish before the crash, leading to a sharp reversal, while in 2023, the stock market is experiencing periods of exuberance followed by bouts of uncertainty. Understanding the psychological aspects of investing is essential for navigating volatile markets and making rational investment decisions.

Recovery and Resilience

Lastly, it’s important to note that after the crashes of 1987 and 2023, the stock market eventually recovered and demonstrated resilience. While the road to recovery may have been bumpy and prolonged, investors who stayed the course and remained invested were ultimately rewarded. These episodes serve as a reminder that while market crashes can be harrowing, they are not the end of the financial world, and markets have historically rebounded over time.

These parallels between the 1987 stock market crash and the events of 2023 offer valuable insights for investors and policymakers alike. Both investors and market participants should heed the lessons of history and remain vigilant in the face of evolving market dynamics.

Recognizing these parallels can help them make informed decisions, navigate market volatility, and protect their investments in both 2023 and beyond. The stock market may continue to change, but the timeless principles of risk management and prudent investing will always be relevant.

More By This Author: