Wednesday, October 24, 2012

THE 25TH ANNIVERSARY OF BLACK MONDAY

From the Desk of Joe Rollins


This past Friday was the 25th anniversary of the worldwide stock markets crash of 1987, often referred to as “Black Monday.” In that single day, the Dow Jones Industrial Average lost 22.61%, its greatest one-day percentage decline. Obviously, there was widespread investor panic and fear, with many economists collectively speculating that “the next few years could be the most troubled since the 1930s.” In fact, it only took two years to recover this loss, and 1987 actually ended with a small gain.

In many regards, Black Monday is the event that most encouraged me to begin Rollins Financial in 1990. I vividly recall receiving telephone calls from panicked tax clients that day (those were the days before communicating by email, texts, Facebook or Twitter). One client in particular expressed utter fear because the market was already down over 300 points at the time we were speaking and he saw no end in sight. I reassured him that if it was down that much, it surely couldn’t go down much more. I was wrong – the Dow declined another 208 points by the day’s end.


After Black Monday, I committed myself to learning more about stock market investing and understanding market moves. I also wanted to better understand the stock exchanges’ relatively new utilization of program trading applications. Back then, computers were believed to be smarter than people since they react non-emotionally to the movements of individual stocks. By the end of 1989, I felt comfortable that I could be a successful asset manager, and Rollins Financial opened its doors inside Rollins & Associates’ office suite on January 1, 1990. As our 23rd year in business draws near, my voracious appetite to learn something new each day continues, and in the ever-evolving world of finance, an asset manager can never know enough.

To this day, many people believe that the stock market crash of 1987 was a result of “computers gone wild!” Program traders basically have specific and defined levels in which trades can be automatically initiated to take advantage of rapid market movements. Until Black Monday, very few people anticipated that a crash of this magnitude could occur over a single day. In fact, the Dow had reached a high of 2,722 points in August of 1987 – a 44% increase over 1986’s 1,895 point closing – and had been selling off precipitously in the six weeks preceding the crash.

On October 19th, the market started selling off rapidly right at the opening bell. It’s believed that program traders broke through initial support levels and the programs instantly sold without regard to liquidity or any other intuitive measure that humans would have exercised. Suddenly, the programs were dumping stocks into an illiquid market with no buyers. At the end of the day, the DJIA’s 22.61% loss was the smallest of the losses in the developed markets. Hong Kong’s losses had fallen 45.5% by the end of October, Australia 41.8%, Spain 31%, The United Kingdom 26.45%, and Canada 22.5%. New Zealand was especially devastated, falling almost 60% from its 1987 peak. Looking back, it would be hard to classify Black Monday as anything short of a financial disaster.


The reason I am reminding you of the devastating events of Black Monday is not to dredge up bad memories for those who lost money in the crash. Rather, I want to illustrate an important, basic investing philosophy that will hopefully be informative to you. Not a week goes by that I don’t receive a call from a client wanting to know why we don’t sell our investments for any given reason (e.g., the election, oil prices, inflation, oil strife, blah, blah, blah…). Many naïve investors believe that it’s wise to sell stocks when these concerns are present and buy them back when the market is lower, but numerous studies have disproven this investing strategy. The following example illustrates this fact:

Assume that on Friday, October 16th, you had been unlucky enough to invest 100% of your capital in the stock market. The DJIA closed at 2,246.74 that day, and by the closing bell on Black Monday, had declined further to 1,738.74 points. Even though 22.61% of your capital had gone to “stock market heaven,” you did nothing and let your investments ride. Today, the DJIA trades at 13,344, which means that over the intervening 25 years, the money that you had invested would have made 7.38% annually, not including reinvested dividends. If you include reinvested dividends, you would have made 9.98% annually.

To further illustrate my point, if you had invested $100,000 on Friday, October 16th and did not touch it in the following years, that investment would be worth approximately $1,078,000 today – a nearly 1,000% gain! At a rate of 9.98% annualized, you would have earned a rate of return in excess of five times the rate of inflation over the intervening 25 years.

Even more extraordinary is that over the last decade, there have been numerous market sell-offs, including the terrible stock market of 1990 and 1991. Additionally, who could forget the tech bubble burst of 2000 and the 35% loss the stock market suffered in the financial meltdown of 2008? Even with these major swings, you would have earned nearly 1,000%.

Furthermore, if you had invested your $100,000 before the crash and you had added an additional $1,000 each month thereafter over the subsequent 25 years, then as of today, you would have invested a principal total of $400,000 ($100,000 plus $300,000 invested on a monthly basis). Including earnings, your account would be worth an approximate whopping $2.5 million today! This approximation is based on average gains and not actual year-to-year gains.

There is no stronger argument for long-term investing than the foregoing examples. Clearly, the potential for creating wealth through stock market investing should not be disregarded. Hardly any other investment class comes close to this potential. So, the next time you wake up in a cold sweat in the middle of the night and think you have a good reason for selling to cash instead of remaining invested, I hope you will think about the examples above. Concisely, market timing is a failed investment strategy for investors seeking long-term wealth.

As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Best regards,
Joe Rollins