by Greg Guenther, Midnight Trader
"I think it’s very likely that we’re seeing, in the next 12 months, an ‘87-type of crash. And I suspect it will be even worse."
— Marc Faber, April 2014
With the Nasdaq pushing toward its dot-com record and the major averages plowing higher, I expect the crash-callers to come out of the woodwork once again.
Back as early as 2013, the doom brigade contended that the market was headed toward an abrupt crash much like we experienced in late 1987— and I wouldn’t be at all surprised if this same theme began popping up again if stocks embark on another extended run.
But if we take the time to break it down, the ghost of 1987 wasn’t actually the horrific monster we thought it was. Sure, it had everyone chasing their tails for a few months. But once it was unmasked, this troublemaker turned out to be harmless to investors in the long run.
Is a similar crash possible sometime in the future? Sure. But I don’t think it’s worth worrying about. Here’s why:
1. The 1987 crash was preceded by an extremely powerful rally that demanded a hard reset…
1986 and 1987 weren’t just delivering investors average returns. The S&P actually gained 60% in the 21 months leading up to the crash. And the majority of these gains were logged between January and August of ‘87:
Have the past 21 months shown any similarities? Not exactly. Instead of a complete explosion to the upside, we have a 32% rise:
I’m not saying the market’s gains since mid-2013 aren’t impressive. But I’m not seeing the insane conditions we would need for a blow-off top. Looks like a steady grind higher…
2. Long-term investors came out of 1987 with their portfolios intact…
The Dow’s record 22% drop on Black Monday is nothing to take lightly. But the aftermath of this crash didn’t slam investors’ returns for year to come. In fact, the main casualty of the crash of ‘87… was the year 1987. The bull market continued in ‘88 right where it left off a year earlier:
I’m pretty sure any long-term investor would take 3-year returns of more than 30% eight days a week. Black Monday didn’t lead to a depression, lost decade, or anything of the sort.
So again, I’m not exactly sure why we should be completely terrified of a similar crash. After all, isn’t this what sidelined investors have been begging for since the bull market kicked into high gear? Don’t they want a chance to buy at better prices?
Maybe we should embrace a hard-reset. Or just admit that our emotions would get the best of us and we would screw it up again— even if we saw it coming:
To be clear, I’m not suggesting that buying the crash of ‘87 was a sure thing— or even easy. Everyone I’ve ever talked to who lived through it tells me it was awful and no one knew what the hell to do. So again, I’m not attempting to downplay the extreme emotions traders and investors surely experienced on Black Monday and the weeks that followed. I wasn’t there. I was busy trading Garbage Pail Kids at recess…
But using the ‘87 crash as a scare tactic? I think we can do better…
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