MoneySunday, October 21, 2007 9:52 PM CDT

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Market ghosts of October not likely to scare investors this time

By E.S. Browning
The Wall Street Journal

With the stock market booming lately, many investors are putting aside worries about the housing slump and the summer’s credit crunch.

At the same time, some are thinking about another anniversary.

Twenty years ago this month, on Oct. 19, 1987, the stock market crashed, a memory that still gives veteran stock traders chills. In a single day, the Dow Jones Industrial Average fell 508 points or 22.6 percent — its worst one-day percentage drop ever (not counting 1914, when the market reopened after being closed for more than four months during World War I).

For reasons analysts don’t fully understand, October has been the month for market crashes and other sudden drops. It was in October that stocks crashed in 1929, falling 23 percent over two days. On Oct. 27, 1997, within a day of the anniversary of the 1929 crash, the Dow Jones Industrial Average fell 7.2 percent, for a drop of 13 percent in two months.

But in most years, October has been a fine month for stocks, often marking the beginning of a fourth-quarter rally. That is what investors are banking on; after two records this month, the Dow industrials are ahead 13 percent this year.

“I think the Fed has taken care of” the summer’s harrowing turbulence — by cutting short-term interest rates, pumping money into the banking system and seeming determined to prevent recession,” says Janna Sampson, co-chief investment officer at money-management firm OakBrook Investments in Lisle.

She was a young money manager in 1987. “I can remember standing in front of a Quotron machine in a crowd of people and mouths were just hanging open,” she says.

Most investors today have little if any memory of the crash. Even many who do believe that, despite surprising similarities between now and then, there are enough differences to assuage their worries.

“The similarities outnumber the differences, but again, that’s not to say a crash will result,” Liz Ann Sonders, chief investment strategist at discount brokerage firm Charles Schwab, wrote in a recent report.

As in 1987, the bull market has been running for five years and is looking somewhat tired.

The dollar was under attack in 1987, as it has been this year. As autumn began, the U.S. and its trading partners were bickering about the weak dollar. Then as now, the U.S. was nervous about its large trade deficit and the inroads of big Asian exporters — Japan back then, China today. Foreign investors were pouring money into the U.S.

In 1987, big buyout firms dazzled Wall Street by taking major companies private, just as they did this year. In both years, lending markets faced disruptions.

This year, as in 1987, sophisticated investors thought they could use computerized techniques to protect themselves from market drops, and in both years they failed. In 1987, investors planned to sell futures in case of a downdraft — a technique known as portfolio insurance. They discovered that when too many people tried to sell the same futures at the same time, there weren’t enough buyers. This summer, sophisticated hedge funds using mathematical models discovered that, if too many tried to cover similar bets at the same time, they all could suffer heavy losses.

But some of the root causes of the 1987 crash appear to be missing today. A big problem 20 years ago was that stocks had risen too far, too fast. At their August high, the Dow industrials were up more than 43 percent for 1987 alone, a stunning short-term gain. They slipped after that, falling especially heavily just before the crash.

This year, the stock gains have been more moderate. Earlier this month, the Dow industrials were up 14 percent for the year.

Stocks don’t look as overpriced today as they did in 1987. Today, the companies in the Standard & Poor’s 500-stock index trade only a little above the historical average of 16 times profits for the past 12 months. In 1987, the S&P 500 was at more than 20 times profits. Interest rates are much lower than they were then and inflation, which was causing the Federal Reserve to fret in 1987, appears to be moderating, at least for now.

Indeed, one of the most significant differences between then and now is the Fed’s position. In 1987, to fight inflation, the Fed was raising interest rates and tightening credit conditions, which made bonds look attractive compared with stocks and amplified worries that stocks were overvalued. Alan Greenspan, then the Fed chairman, didn’t loosen the credit reins until after the crash.

This time, the Fed already has stepped in, lowering target short-term interest rates and pumping money into the banking system. Frozen credit markets are a bigger worry than overvalued stocks, and the Fed’s early action has helped stocks rebound.

Despite the continuing housing crisis and difficulties that many borrowers still face raising money, many investors believe the worst of the year’s troubles are over. While they wouldn’t be surprised to see some stock jitters crop up around the time of the anniversary, they see stocks continuing their rebound.

“Hardly anyone is thinking about” the 1987 crash, says Phil Roth, chief technical market analyst at New York brokerage firm Miller Tabak. Roth thinks U.S. stocks may surprise people by declining further, but he thinks there are bigger risks in foreign markets, which have risen more rapidly.

“The next crash will probably be where the most speculation is. The most speculation now is not in U.S. stocks (not many of them, anyway). The speculation is in Asia, primarily China and India,” Roth says.

Another source of reassurance: Frightening though 1987 was, with some stock brokers literally ceasing to answer their phones on the day of the crash, the worst was over on that day.

Unlike 1929, when the crash led to the Great Depression, the economy kept growing in 1987. The crash actually marked the market’s low point, and stocks recovered the next day, beginning a new bull market right then. By year’s end, stocks had risen enough that the Dow industrials showed a gain for the year.

Some investors now worry that current economic problems could be worse than in 1987, and could be longer lasting, even without a crash or a bear market.

The 1987 crash was about overvalued stocks and rising interest rates, and it didn’t seriously hamper economic growth. The troubles this year include the threat to consumer spending from the housing slump and credit problems.

“The disaster in 1987 was different than others, because it happened so fast. It was hard to know how far the tentacles were going to reach,” says Steve Finerty, chairman of Argent Capital Management in St. Louis. “Of course, in 1987, after three or four months, it was ancient history. I don’t think it is going to be that way this time, but you never know. Things can change fast.”

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