World View: Economists Baffled on 30th Anniversary of 1987 Stock Market Panic

(FILES) A file photo dated 19 October, 1987 shows a trader (C) on the New York Stock Exchange shouting orders as stocks were devastated during one of the most frantic days in the exchange's history. The Dow Jones index plummeted 22.68 percent, some 508 points, to close at 1,738.41 points …
MARIA BASTONE/AFP/Getty Images

This morning’s key headlines from GenerationalDynamics.com

  • Mainstream economists baffled about stock market panic of October 19, 1987
  • The 58 Year Hypothesis: False panics of 1914 and 1987
  • Examples of the 58 Year Hypothesis: Swine Flu, Iraq War, Israel-Hezbollah war

Mainstream economists baffled about stock market panic of October 19, 1987

The Philadelphia Inquirer on October 20, 1987, after Black Monday
The Philadelphia Inquirer on October 20, 1987, after Black Monday

They are calling Monday, October 19, 1987, the “worst day in stock market history,” it fell 22 percent in one day (equivalent to a fall of 5000 points today). Analysts and economists were on television all day on Thursday telling sad stories about how shocked they were on that day, but they were completely baffled about why it happened.

The development of generational theory and Generational Dynamics has revealed numerous important historical patterns generated by the regular changes in generations.

One of the most significant discoveries in the development of generational theory is an explanation of the stock market crash of Monday, October 19, 1987 – why it occurred at all, why it occurred in 1987 rather than, say, in 1980 or 1990, and why the stock market recovered so quickly.

Here are some Thursday media excerpts offering explanations:

  • “What was to blame? Heightened hostilities in the Persian Gulf, fear of higher interest rates, a five-year bull market without a significant correction, and computerized trading that accelerated the selling and fed the frenzy among the human traders.”
  • Some blamed increasingly computerized trading for a wave of early sales that triggered panic among institutional investors. Others cited House Ways and Means Committee Chairman Dan Rostenkowski’s interest in market-punishing tax hikes. Still others pointed to global tensions that sparked fear of a conventional U.S. war in the Middle East and/or a trade war with West Germany. … Journalist Tim Metz offered a more provocative theory: … He suggests that government regulators, exchange officials and the “market makers” who sustain trading are parties to a huge — and, until now, undetected — market manipulation scheme.”
  • One of the principal causes of the crash was “portfolio insurance,” which sought to protect investors by selling during market tumult. However, the computers kept selling and never stopped on Black Monday until some leading market participants … stepped in as buyers to help stop the bleeding.”

Jeff Cox of CNBC claims that, unlike today, “the 1987 [stock market] was stratospheric, doubling in about two years.” This is the kind of nonsense you see from analysts who have no clue what’s going on. In 1987, the S&P 500 price/earnings ratio index was 14, which means that stocks were fairly priced at the historic average. Today, the P/E ratio is 25, indicating that stocks are in a huge bubble.

If you want to figure out why the “the worst day in stock market history” occurred in 1987, then you have to ask what was unique about 1987 that made it different from 1980, 1985, 1990 or 1995?

If you look at the proposed explanations listed above, they explain nothing. Let’s take one example: global tensions, and fear of a Mideast war. Well, just a few years earlier we had had the Iran hostage crisis in 1979, and the deaths of 300 American and French troops in the 1983 bombing of the Beirut, Lebanon, barracks by Hezbollah. If global tensions caused the panic in 1987, why did they not cause a panic in those earlier years?

None of the other proposals explains why 1987 was a special year, as opposed to all the others.

But from the point of view of Generational Dynamics, what made 1987 a special year, different from all the others, was that it was 58 years after the crash of 1929. This leads us to one of the most interesting discoveries of generational theory – the “58 Year Hypothesis.” CNN and San Diego Union Tribune and CNBC and Market Watch

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The 58 Year Hypothesis: False panics of 1914 and 1987

So why did all the senior managers of financial firms panic on October 19, 1987, and join the stock market selloff that caused the market to fall 22 percent in one day?

If we assume that all of these senior managers were roughly 63-68 years old in 1987, they would have been 5-10 years old in 1929.

Now imagine that you are a 5-10-year-old child in 1929, leading a happy life with parents who have plenty of money because they had taken advantage of the stock market bubble in the 1920s. Now imagine that, one day, your parents lose everything. Your whole life is turned upside down, and suddenly your family is living under a bridge and depending on soup kitchens to survive. This is something that traumatizes you and affects your entire life.

And here is the important part: It is not just you. It is every child your age. As you and your age cohort grow older, you share this common memory of the 1929 catastrophe – something that younger children and younger people have no personal memory of.

So now move forward to 1987, and you are 63-68 years old, and something happens in the stock market that frightens you. It could be almost anything. You talk it over with your other 63-68-year-old exec friends, and you realize that you all recognize the danger, but that managers younger than you have no idea because they did not live through it before. So you all tell younger people that you think there is going to be a repeat of the 1929 crash, causing a panic. But it is a false panic, because stocks are fairly priced, not in a huge bubble as in 1929.

This is not the first time this has happened. In 1914, there was a similar false panic, occurring 57 years after the stock market crash of 1857. And, once again, the market recovered quickly from the panic, because stocks were fairly priced.

The 1914 panic had an enormous impact on investors because it ended so quickly, and kept investors from understanding the impact of the 1929 stock market crash. John Kenneth Galbraith’s 1954 book The Great Crash – 1929, explained how the brief 1907 and 1914 panics contributed to the 1929 disaster:

A common feature of all these earlier troubles [previous panics] was that having happened they were over. The worst was reasonably recognizable as such. The singular feature of the great crash of 1929 was that the worst continued to worsen. What looked one day like the end proved on the next day to have been only the beginning. Nothing could have been more ingeniously designed to maximize the suffering, and also to insure that as few as possible escaped the common misfortune.

The fortunate speculator who had funds to answer the first margin call presently got another and equally urgent one, and if he met that there would still be another. In the end all the money he had was extracted from him and lost. The man with the smart money, who was safely out of the market when the first crash came, naturally went back in to pick up bargains. … The bargains then suffered a ruinous fall. Even the man who waited out all of October and all of November, who saw the volume of trading return to normal and saw Wall Street become as placid as a produce market, and who then bought common stocks would see their value drop to a third or fourth of the purchase price in the next twenty-four months. … The ruthlessness of [the stock market was] remarkable. (p. 108-109)

This analysis by Galbraith is the basis for what I call the Principle of Maximum Ruin: That a real financial crisis will ruin the maximum number of people to the maximum extent possible. The commonly heard phrase “buy the dip” describes what happens. Since investors don’t believe that a real stock market crash is possible, they buy more stocks whenever prices dip. So they keep losing money until they lose everything. This is what happened in 1929, and it’s what will happen in the coming panic and financial crisis.

Examples of the 58 Year Hypothesis: Swine Flu, Iraq War, Israel-Hezbollah war

I formulated the 58 Year Hypothesis over ten years ago when I accidentally noticed what seemed to be a remarkable coincidence.

I’m now referring to the “swine flu” panic of 1976. The public became hysterical over the possibility of a new flu pandemic that could kill millions of people, repeating the catastrophe of the Spanish Flu epidemic of 1918. Responding to public demands, the government prepared millions of doses of swine flu vaccine. President Gerald R. Ford authorized a mass inoculation program, and 45 million Americans – more than 20 percent of the population – were vaccinated. The whole thing was a fiasco because there was no epidemic and because hundreds of people died from a negative reaction to the vaccinations.

The swine flu panic of 1976 was a false panic that occurred exactly 58 years after the Spanish Flu epidemic of 1918. Once again, the 58 Year Hypothesis explains why the year 1976 was unique. There was no similar flu panic in 1960, 1965, or 1970. It occurred in 1976 because it was 58 years after the Spanish Flu epidemic and 5-10 year old children who had lost their parents and friends in 1918 panicked in 1976, when they were 63-68 years old, fearing that it would happen again.

Once I identified this “coincidence,” I began looking for other possible examples, and it turns out that the 58-year time span occurs rather frequently in generational theory. It seems that when an entire society is traumatized by an unexpected event that was foreseeable but not foreseen, then there is a panic 58 years later that the event will happen again.

The Iraq ground war of 2003 is considered a mistake today, but in 2003 it was extremely popular because the entire country was anxious over Saddam Hussein’s development and use of chemical weapons. It occurred 58 years after the use of nuclear weapons on Hiroshima and Nagasaki in 1945. Why was the year 2003 unique? Saddam had been developing and using WMD’s for 20 years, and there was no panic. But 2003 was unique because it was 58 years after 1945.

In 2006, Hezbollah abducted two Israeli soldiers near the Lebanon border. Israel went into a state of total panic, and launched the war in Lebanon within four hours, with no plan and no objectives. The war was a total disaster for Israel. There had been other prior confrontations with Hezbollah and Palestinian terrorists prior to 2006. What made 2006 special? It occurred 58 years after the genocidal war between Jews and Arabs in Palestine in 1948.

There is still plenty of research to be done on the 58 Year Hypothesis to determine exactly why it happens, what types of events trigger it, and what are other examples. But returning now to the false panic of 1987, go back and read the moronic explanations by mainstream economists and analysts, and you’ll see that the 58 Year Hypothesis is the only one that actually makes sense. Jerusalem Post (30-Apr-2007) and LA Times (27-Apr-2009)

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KEYS: Generational Dynamics, Panic of 1987, Dan Rostenkowski, Tim Metz, Jeff Cox, 58 Year Hypothesis, John Kenneth Galbraith, Gerald Ford, Swine flu, Spanish Flu, Israel Hezbollah war, Iraq war
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