Dow Jones Industrail Average (DJIA) is a stock market index just like our local STI which consists of 30 major companies which includes: 3M, Amex, Boeing, Coca-Cola, ExxonMobil, General Electric, Goldman Sachs, Apple, Microsoft, United Technologies, Walmart and more.
I've never participated in any market crashes before. Throughout my life on earth, I've only been through GFC in 2008. However as DJIA is breaking its all time record high and closing at 22,203.48 yesterday. As such, I've decided to look-back into market crashes, economic crises and reading more about them. I'll look back into 30 years ago, starting with the Black Monday in 1987.
On 19 October 1987, the stock market around the world crashes. DJIA fell by 508 points (22.61%) to 1,738.74. The largest one-day percentage drop in history. $500 billion in market capitalization was evaporated from DJIA.
Impacts on Straits Time Index (STI)
STI shredded 12% or 170 points to 1,223.28
This is also the biggest one day tumble in local stock market history. The drop also translates to S$15 billion loss from the market in a day.
In 1985 and 1986, US economies began shifting from a rapidly growing recovery for the early 1980s recession. The 1980s recession is an event of severe global economic recession. One of the cause was the Federal Reserve's contractionary monetary policy which was sought to deal with the for high inflation.
The stock market then go on a super-bull run in the 1986-1987. The bull market had been fueled by the low interest rates, hostile takeovers, leveraged buyouts and merger mania. Many companies raises capital to buy each other out - the companies believe that they will be able to grow exponentially by constantly acquiring other companies. Back then, investors rushed to buy their stocks hoping to benefit from the super-charged bull market.
In early 1982, Dow closed at 776.92. Dow has peaked in August 1987 at 2722 points, a 44% increase over 1986's closing price of 1895 points.
Causes of market crash includes includes program trading, overvaluation, illiquidity and market psychology.
The crash was done by program traders. In program trading, computers perform rapid stock executions based on external inputs such as the price of related securities. Mass panic selling caused by the crowd has elevated the crash. Panic selling causes a sharp decline in price as the investors just want to get out of the investment with little regard for the price at which they sell. Investors rush to calling their brokers to sell off their stocks with the fear of losing everything. This is caused by pure emotion and fear, rather than evaluating their fundamental. Almost every market crash is a result of panic selling.
Majority of the investors are selling did not know why they're selling for. The only thing they know is that everyone is selling. This emotionally-charged behavior has caused the stock market to crash.
Circuit breakers were introduced after the Black Monday to halt stocks from trading if they plummet too quickly.
I've done a deeper research on the behavioral economics to understand more about "emotions" in investing from the net.
Behavioral economics is the studies of effects in psychological, social, cognitive and emotional factor on the economic decisions.
There are 3 prevalent themes in behavioral finances:
1. Heuristics - Humans make 95% of their decisions using mental shortcuts or rule of thumb
2. Framing - The collection of anecdotes and stereotypes that make up the mental emotional filters individuals rely on to understand and respond to events.
3. Market inefficiencies - These include mis-pricing and non-rational decision making.
Now all these is done without consideration to it's fundamental of the business they're buying into. It seems that the many investors back then has been affected by the noises from the market to buy and sell. "Buying in bull, selling in bear"
Fun Fact: Buffett however, took the advantage of the lower price in Black Monday and began building his position in Coca-Cola. One of his most successful investment ever. No doubt his favorite stock. Buffett had cashed-in more than $1 billion of Coca-Cola stock in 1988 which is equivalent to 6.2% of Coca-Cola. Today, his stakes in Coca-Cola is worth $16.7 billion and it pays Buffett $560 million in dividends every year. Now, this is almost half of what he paid in 1987.