Echoes of the late eighties crash persist in the markets
Echoes of the late eighties crash persist in the markets
By Tony Jackson
Published: May 20 2006 03:00 | Last updated: May 20 2006 03:00. Copyright by The Financial Times
For those of a certain age, some of the recent goings-on in the markets are reminiscent of the dotcom bust six years ago. For those of a less certain age, such as myself, a more remote parallel comes to mind - the late 1980s.
In one sense, let us hope the parallel is inexact. In one day in October 1987 the Dow fell 500 points, equivalent to 2,500 points today. Anyone predicting that now would be taken away in a van. But the echoes persist. Then as now, people had fretted for some time that the markets had gone up too far, too fast. Indeed, the Dow had peaked in August 1987.
So why did it collapse in October? Because it did, seems to be the answer. The Yale academic Robert Shiller polled US investors immediately after the crash, asking just that question. The commonest reason given was that the market had been overpriced.
In the circumstances, that might seem a statement of the obvious. But Mr Shiller also asked whether investors thought the crash was due to a specific cause, such as profits or interest rates, or to investment psychology. Two-thirds chose the latter.
So why had they kept on buying before? That at least is an easy one. What we have here is the Greater Fool Theory.
This says that even though you are perfectly aware a thing is overvalued - copper, say, or shares in a fly-by-night oil explorer - you keep buying it anyway. Why? Because the thing is still going up. When the time comes, you will find a Greater Fool to take it off your hands. Until, of course, the music stops and the Greater Fool turns out to be you.
Here is another possible parallel. In October 1987, part of the problem was the recent introduction of computerised programme trading, designed to sell automatically when a certain trigger was reached. What no one seemed to have spotted was that in a crash, the computers would keep on selling against each other until someone switched them off.
Today, such programmes would seem laughably primitive. What we have instead are equity and credit derivatives, in vast quantities. These are of mind-hurting complexity and even the people who trade them have PhDs in physics (yes, really). No one seems very sure what would happen if that lot blew up, but I for one am rather keen not to find out.
Another slightly unsettling thought is that in 1987, the Wall Street crash was in one sense a surprise. People thought the US market was rather overvalued, but the Japanese market was screamingly so. So when the collapse happened, they were looking in the wrong direction.
Even more bizarrely, the Tokyo market shrugged off the Dow's crash and kept on climbing for another two years. By the end of 1989 it was nearly 50 per cent higher again. And then it had a real crash. The fall in the Dow, it turned out, was really only a blip in the long bull market that kept going until 2000. Tokyo's Nikkei index, by contrast, is still less than half its 1989 peak.
So are we headed for further big falls this time round? As the 19th century Baron Rothschild said in reply to a similar question, if I knew that, dear lady, I should be a rich man. For what it is worth, I doubt it. But I worry just the same.
It is not so much that shares are obviously overpriced, in the developed markets at any rate. It is rather that everything else has gone up as well, from oil to oil paintings.
Even within the equity markets, it is striking that nothing looks obviously cheap any more. Contrast the dotcom boom, when a lot of traditional companies were decidedly cheap and went up accordingly when boom turned to bust.
As for gold, I am not about to pronounce on whether it is worth $700 an ounce. I merely point out that when it peaked at $500 in late 1987, it had risen by $200 since 1985.
Similarly, I have no firm views on whether interest rates and bond yields are too low. But I would prefer it if some UK government index-linked bonds had not been trading at such bizarrely low yields lately. And I see the French bank Société Générale has just spent an extra €6.5bn (£4.4bn) on hedging its corporate loans, in preparation - as it tactfully puts it - for "more normal trading conditions".
I also note that, as this paper reported a few days ago, there has been an unprecedented boom in corporate bond issues in the past week or two and also in company flotations. That might be because everyone is in such a terrifically good mood. Then again, it might not.
As for the rise of the hedge funds and private equity, don't even get me started. But that is how it is with investor psychology. There are always things to worry about. But for a long time - the past three years, in this case - you don't let them bother you. And then you do.
And after all, parallels can be pressed too far. In the UK in 1987, the crash passed off fairly quickly and markets resumed their upward march. Then, a couple of years later, inflation took off and interest rates went to 15 per cent. The housing market slumped, and a large part of the retail trade with it.
That couldn't happen today. We have learnt our lesson, and now we know better. Don't we?
The writer is an FT contributing editor
By Tony Jackson
Published: May 20 2006 03:00 | Last updated: May 20 2006 03:00. Copyright by The Financial Times
For those of a certain age, some of the recent goings-on in the markets are reminiscent of the dotcom bust six years ago. For those of a less certain age, such as myself, a more remote parallel comes to mind - the late 1980s.
In one sense, let us hope the parallel is inexact. In one day in October 1987 the Dow fell 500 points, equivalent to 2,500 points today. Anyone predicting that now would be taken away in a van. But the echoes persist. Then as now, people had fretted for some time that the markets had gone up too far, too fast. Indeed, the Dow had peaked in August 1987.
So why did it collapse in October? Because it did, seems to be the answer. The Yale academic Robert Shiller polled US investors immediately after the crash, asking just that question. The commonest reason given was that the market had been overpriced.
In the circumstances, that might seem a statement of the obvious. But Mr Shiller also asked whether investors thought the crash was due to a specific cause, such as profits or interest rates, or to investment psychology. Two-thirds chose the latter.
So why had they kept on buying before? That at least is an easy one. What we have here is the Greater Fool Theory.
This says that even though you are perfectly aware a thing is overvalued - copper, say, or shares in a fly-by-night oil explorer - you keep buying it anyway. Why? Because the thing is still going up. When the time comes, you will find a Greater Fool to take it off your hands. Until, of course, the music stops and the Greater Fool turns out to be you.
Here is another possible parallel. In October 1987, part of the problem was the recent introduction of computerised programme trading, designed to sell automatically when a certain trigger was reached. What no one seemed to have spotted was that in a crash, the computers would keep on selling against each other until someone switched them off.
Today, such programmes would seem laughably primitive. What we have instead are equity and credit derivatives, in vast quantities. These are of mind-hurting complexity and even the people who trade them have PhDs in physics (yes, really). No one seems very sure what would happen if that lot blew up, but I for one am rather keen not to find out.
Another slightly unsettling thought is that in 1987, the Wall Street crash was in one sense a surprise. People thought the US market was rather overvalued, but the Japanese market was screamingly so. So when the collapse happened, they were looking in the wrong direction.
Even more bizarrely, the Tokyo market shrugged off the Dow's crash and kept on climbing for another two years. By the end of 1989 it was nearly 50 per cent higher again. And then it had a real crash. The fall in the Dow, it turned out, was really only a blip in the long bull market that kept going until 2000. Tokyo's Nikkei index, by contrast, is still less than half its 1989 peak.
So are we headed for further big falls this time round? As the 19th century Baron Rothschild said in reply to a similar question, if I knew that, dear lady, I should be a rich man. For what it is worth, I doubt it. But I worry just the same.
It is not so much that shares are obviously overpriced, in the developed markets at any rate. It is rather that everything else has gone up as well, from oil to oil paintings.
Even within the equity markets, it is striking that nothing looks obviously cheap any more. Contrast the dotcom boom, when a lot of traditional companies were decidedly cheap and went up accordingly when boom turned to bust.
As for gold, I am not about to pronounce on whether it is worth $700 an ounce. I merely point out that when it peaked at $500 in late 1987, it had risen by $200 since 1985.
Similarly, I have no firm views on whether interest rates and bond yields are too low. But I would prefer it if some UK government index-linked bonds had not been trading at such bizarrely low yields lately. And I see the French bank Société Générale has just spent an extra €6.5bn (£4.4bn) on hedging its corporate loans, in preparation - as it tactfully puts it - for "more normal trading conditions".
I also note that, as this paper reported a few days ago, there has been an unprecedented boom in corporate bond issues in the past week or two and also in company flotations. That might be because everyone is in such a terrifically good mood. Then again, it might not.
As for the rise of the hedge funds and private equity, don't even get me started. But that is how it is with investor psychology. There are always things to worry about. But for a long time - the past three years, in this case - you don't let them bother you. And then you do.
And after all, parallels can be pressed too far. In the UK in 1987, the crash passed off fairly quickly and markets resumed their upward march. Then, a couple of years later, inflation took off and interest rates went to 15 per cent. The housing market slumped, and a large part of the retail trade with it.
That couldn't happen today. We have learnt our lesson, and now we know better. Don't we?
The writer is an FT contributing editor
posted by Carlos T Mock at 12:34 PM
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