Three money managers who lived through the 1987 stock-market crash warn of danger today
Published: Oct 31, 2017 1:49 p.m. ET
‘I would take some money off now because ... there are clear signs of deranged valuations,’ says Gabelli fund manager Lawrence Haverty
A trader on the New York Stock Exchange on Oct. 19, 1987 — Black Monday.
When the stock market crashed on Oct. 19, 1987, investors panicked. It was an unfamiliar event — the previous decline of a similar magnitude occurred 58 years earlier, in 1929.
Now, 30 years after Black Monday in 1987, there are professional investors still at work who lived through that fateful day. In interviews, three of them talked about their experiences, offered insights into warning signs and gave advice on how to handle major downturns.
• Lewis Altfest, president of Altfest Personal Wealth Management, which manages about $1.3 billion for private clients. Altfest founded the firm in 1983 after working as a general partner and director of research at Lord, Abbett & Co.
• Brian McMahon, chief investment officer of Thornburg Investment Management, co-manages the $2.5 billion Thornburg Global Opportunities Fund THOAX, +1.06% and the $16.1 billion Thornburg Investment Income Builder FundTIBAX, -0.14% In October 1987, McMahon was managing Thornburg’s laddered maturity bond portfolios.
• Lawrence Haverty, associate portfolio manager of the $231 million Gabelli Multi-Media TrustGGT, +1.71% In October 1987, Haverty co-managed the Putnam Growth Fund and the Putnam Convertible Fund, which had combined assets of about $2 billion.
First, let’s take a look at a chart showing the Dow Jones Industrial Average DJIA, +0.12% from 1987 through 1989:
The Dow dropped 4% on Friday, Oct. 16, 1987, and then plunged 23% on Black Monday.
There were many factors contributing to what was an unprecedented event to almost everyone on Wall Street. Those included a 44% run-up for the Dow from the end of 1986 through Aug. 25, 1987.
That jump was spurred, in part, by the Tax Reform Act of 1986. Long-term interest rates were rising quickly, which fed the atmosphere of uncertainty. The wild selling on Black Monday was driven in great part by the use of “so-called portfolio insurance, which everyone was selling and was basically stop-loss orders,” according to McMahon.
The New York Stock Exchange now has “circuit breakers” to temporarily halt trading on days of major declines. But those measures don’t prevent drops over multiple trading sessions.
Heading into Black Monday
“When my clients get nervous, they call,” Altfest said.
So after the Oct. 16, 1987, decline, he went to his office the next day, a Saturday, to make himself available to them. He tried to keep clients from panic-selling, but during a period of market turmoil, memories are short and people lose faith in the market’s ability to recover and set new records.
Altfest Personal Wealth Management
Lewis Altfest, president of Altfest Personal Wealth Management.
“Many people just got out and waited until the market came back sizably, before getting back in. So that didn’t turn out so well for them,” Altfest said.
Charles Schwab Corp. had begun taking client orders on weekends to be executed on Monday. “I called them and said I wanted to know the ratio of buy orders to sells. The sells were ... maybe 12 to 1. So then I put in orders for about an 8% drop in the market,” Altfest said.
Altfest went in with heavy investments of accumulated cash after the Dow dropped 8% early on Black Monday. He couldn’t know that the market would decline another 15% that day, but said, “I was thrilled eventually” after the market recovered.
Black Monday was also a rough one for bond investors. A sharp movement in yields for 30-year U.S. Treasury bonds helped set the stage, with the yield jumping to 9.61% on Oct. 1, 1987, from 7.39% at the beginning of the year, according to the Federal Reserve.
“Today, if bond rates were to go up [by a similar amount], it would probably send a shudder through equity markets. So we went out of 1986 through most of 1987 with quite a bit of enthusiasm for equities,” McMahon said.
Thornburg Investment Management
Brian McMahon, chief investment officer of Thornburg Investment Management.
“I was not managing equity money then, but people were selling whatever they could sell. In my case, we were able to buy pre-refunded municipal bonds with [yields] in the teens,” McMahon said.
Haverty quoted a colleague of his who said “higher interest rates work,” which means rising rates can quell an overheated economy and inflation, “but eventually higher interest rates would cause problems,” he said.
Haverty pointed out that October 1987 was part of the “Milken Era,” when Michael Milken and Drexel Burnham Lambert took advantage of investors’ hunger for high yields and pioneered varieties of high-yield debt securities.
“When I took over the convertible fund in 1984, it had $200 million in assets and we grew it to over a billion and a half dollars [in 1987], which was a huge amount of money in a small asset class at that point,” Haverty said.
He saw clear signs that the market for convertible bonds was overheated heading into the October crash. “Either you got good companies issuing convertibles at a preposterous price, or you got preposterous companies issuing convertibles at good prices,” he said.
Lawrence Haverty, associate portfolio manager of the Gabelli Multi-Media Trust.
Early on Tuesday, the day after Black Monday, Haverty “felt very comfortable” after the Federal Reserve made “a powerful statement” before the market open. He said that expressing his newfound confidence, while describing his decision for one of his funds to purchase shares of Caesars World (now Caesars Entertainment Corp. CZR, +2.78% ) on Tuesday to his superiors at Putnam, eventually led to his firing in December 1987.
“I still have nobody to counterclaim my being the first professional fired” as a result of the crash, he said. The story had a happy ending, however. After receiving his severance pay in December, Haverty bought Caesars shares for himself and made “10 times on my investment,” he said.
Warning signs in the market today
“I think the bond market is generally overvalued, so it wouldn’t surprise me if we were to see upward pressure on interest rates and the widening of spreads on corporate credit,” McMahon said. Along with the Federal Reserve’s plan to draw down its securities investments by $30 billion a month, a possible tax-reform bill would lead investors to expect the economy to heat up, which would push interest rates higher and bond prices lower. Higher interest rates typically mean more volatility for stocks.
“I think that relative to norms, the market has an extra 20% in it,” Altfest said.
He made it clear that he was not predicting an immediate decline and that the current market is different from 1987’s, as well as the late 1990s tech bubble and the pre-crisis climate of 2007.
Haverty sees valuations of some stocks as serious warning signs for the health of the market.
“I work in the media area and have been totally wrong about Amazon and Netflix,” he said. “People are paying multiples of cash flows for these business (which essentially are not economically profitable) that basically defy gravity.”
As of Tuesday’s market close, shares of Amazon.com Inc. AMZN, -0.50% traded for 127 times the consensus 2018 earnings-per-share estimate among analysts polled by FactSet, while Netflix Inc. NFLX, -0.98% traded for 89 times estimated 2018 EPS.
This chart shows how the ratio of price to trailing 12 months’ earnings has changed for the benchmark S&P 500 Index SPX, +0.09% since 1999:
So valuations have risen considerably during the bull market that began in March 2009. But we’re nowhere near the levels of March 2000, when S&P 500 member companies were trading for a weighted 30.5 times trailing earnings, according to FactSet.
Haverty said investors’ “mad quest for yield,” after so many years of very low interest rates, was a dire warning sign for the market. He cited the popularity of Tajikistan’s government bonds as one example.
Advice for investors
“I would say, if people are exposed to the frothier edge of the bond market, to take some gains,” McMahon said.
Altfest advises investors to “look at whether the companies they invest in are making money and how high the P/E ratios are.” Then, if the market takes a big fall, “take a deep breath and go outside,” he said.
In other words, keep in mind that the stock market has always recovered from crashes. If you wish to time the market, the danger is that you will wait too long for the market to recover before you jump back in. You will miss opportunities and possibly even buy back in at a higher level than the market was at when you sold. History shows that most non-professionals were better off not selling into a panic.
Haverty said that despite his opinion that stock valuations are very high, he is nearly 100% invested in equities. But when asked what he would do right now if he were a non-professional investor, he said: “I would take some money off now because valuations are high and there are clear signs of deranged valuations.”