Black Monday for the US market became Black Tuesday in Australia. The US market had fallen by 22% on Monday night and the Australian market crashed by 25%.
My recollections are that the warning signs were observable in 1987. The US equity market had peaked in August 1987 and staged a weak recovery before weakening in the week before 20 October.
More than most markets, the Australian equity market had been driven by debt with much of it feeding the corporate plays of many long forgotten entrepreneurs. However, the biggest and most memorable debt player was Robert Holmes à Court, whom had been stalking BHP through his debt-laden Bell Group. He may not have invented leverage but Holmes à Court convinced our major banks to lend against the listed security of his massive BHP holding – the price of which had been constantly massaged higher through takeover bids, option trades and hedging.
That leads me to my lessons from the 87 crash.
First, the benefits of “leverage” built in a bull market and based on market prices (for security) are totally usurped in a market correction. Twenty years later in 2007 the lessons of leverage had been forgotten and many a levered portfolio was wiped out in 2008.
Second, is to observe and therefore benefit from the effects of force selling. Leverage transfers control of the equity asset from the investor (with leverage) to the provider of the leverage. The bank or financier will always cut a margin loan to recover their exposure. Buying from banks or forced sellers is a lucrative practice.
Third, every economic, and therefore stock market, cycle matures into a “nonsense” stage. The maturity of a market is not measured by the maturity of the participants but the rehashing of hope that is sold to investors whom come late to a bull market. The catch up investors whom are chasing a bull market always push it beyond reality. Whilst high pricing is a feature (well above value), it is more starkly seen in the craziness of the “new” business concepts that emerge in a tired bull market. I do recall Perth entrepreneurs in 1987 that had discovered (they claimed) that water could be converted into a type of oil for engines. Another classic was the entrepreneur whom invented (and floated on the ASX) a non-inflammable substance that could be used to build airplanes. A passenger would not be burnt in an air crash – if they survived the impact from falling 40,000 feet!
Finally, history repeats and the basic traits of human fragility are constant. With regards to equity investment we all want to believe that this time is different (but it never is); that equities will never fall or fail (they will); that entrepreneurs will not be driven by greed and feed off the greed of investors (they mostly do) and that value based investing is a fallacy whose time is over – sorry it always will endure and for much longer than a normal human life.