10/18/2012 11:45 PM ET|
Another crash like 1987 is inevitable
New research suggests that periodic free-falls in the market are unavoidable. Investors need to cushion their portfolios.
A trader holds his head on the floor of the New York Stock Exchange on Oct. 19, 1987, after the Dow crashed 22.6%.
Prepare yourself for another stock market crash as big as the free-fall in October 1987.
That's a daunting prospect, indeed. At current levels, such a decline would mean a plunge in the Dow Jones Industrial Average ($NDU) of more than 3,000 points in a single trading session.
And we're kidding ourselves if we think that market regulatory reforms such as circuit breakers will be able to prevent it.
These sobering truths are what emerge from a fascinating line of recent academic research into the frequency of market crashes. Recognizing them is perhaps the best way for us to respect this week's 25th anniversary of the Oct. 19, 1987, "Black Monday" crash, when the Dow plunged 22.6%.
This research traces to "A Theory of Large Fluctuations in Stock Market Activity," a study you can find on the Social Science Research Network that was conducted a decade ago by Xavier Gabaix, a finance professor at New York University, and three scientists at Boston University's Center for Polymer Studies: H. Eugene Stanley; Parameswaran Gopikrishnan, and Vasiliki Plerou.
In numerous follow-up studies, Gabaix said in a telephone interview earlier this week, the original findings have only been strengthened.
No way to stop losses
The researchers crafted a complex mathematical formula for predicting the frequency of large daily stock market movements. Though they believe their formula rests on a solid theoretical foundation, the proof of the pudding is in the eating. And they found that not only does the U.S. stock market over the last century closely adhere to the formula, so do international markets.
A single-session drop of at least 20%, for example, is predicted -- over long periods -- to occur once every 104 years, on average, but it could happen at any time. That's why you always have to prepare for it, because you don't know when it will occur.
If the frequency of crashes of various magnitudes is predictable, shouldn't precipitous slides also be preventable?
Gabaix says no. Crashes are an inevitable feature of the investment arena because every market, to a more or less similar degree, is dominated by its largest investors. When those large investors collectively want to get out of stocks, which will happen on occasion, they will find ways to circumvent any downside protections, such as circuit breakers, that may be in place.
Gabaix therefore recommends that all of us -- whether individuals or large institutional investors, such as banks and mutual funds -- cushion our portfolios so that a crash as large as 1987's wouldn't be fatal.
Unfortunately, he added, for most investors that's easier said than done. Those cushions are a drag on portfolio performance as long as the market doesn't plunge. After big stretches in which no major crash occurs, the pressure becomes overwhelming to toss out those cushions in pursuit of short-term profits.
The bottom line? Regulators are tilting at windmills in trying to formulate reforms that would prevent large daily market drops. Even worse, these regulatory efforts lull gullible investors into a false sense of security.
Repeat after me: Another stock market crash as big as 1987's is going to happen. Period.
More from MarketWatch:
VIDEO ON MSN MONEY
Trust me another 4 more years of barry and benny and the ink jets printing more and more worthless Federal Reserve notes. Taking in $7 dollars and spending $11, borrowing 1.1-1.4 trillion every years. You don't have to use any model, the whole thing is about to collapes.
Does this raise any eye brows?
In recent times, fiat failures have become more common occurrences. For the sake of time, I won’t go into extensive details of all these examples of paper money failures, because there are SO many. But here you have it:
In 1932, Argentina had the eighth largest economy in the world before its currency collapsed. In 1992, Finland, Italy, and Norway had currency shocks that spread through Europe.
In 1994, Mexico went through the infamous “Tequila Hangover,” which sent the peso tumbling and spread economic hardships throughout Latin America.
In 1997, the Thai baht fell through the floor and the effects spread to Malaysia, the Philippines, Indonesia, Hong Kong, and South Korea.
The Russian ruble was not the currency you wanted your investments denominated in in 1998, after its devaluation brought on economic recession. In the early 21st century, we have seen the Turkish lira experience strokes of hyperinflation similar to that of the mark of Weimar Germany.
In present times, we have Zimbabwe, which was once considered the breadbasket of Africa and was one of the wealthiest countries on the continent. Now Mugabe’s attempts at price controls, combined with hyperinflation, have the nation unable to supply the most basic essentials such as bread and clean water.
Maybe these right wingers who can`t spell Obama will learn how to spell his
name in his second term.
Marco Polo made this statement in regards to fiat:
“Population and trade had greatly increased, but the emissions of paper notes were suffered to largely outrun both…All the beneficial effects of a currency that is allowed to expand with a growth of population and trade were now turned into those evil effects that flow from a currency emitted in excess of such growth. These effects were not slow to develop themselves…The best families in the empire were ruined, a new set of men came into the control of public affairs, and the country became the scene of internecine warfare and confusion.”
CHICKEN LITTLE, THE SKY IS FALLING.I SEE everybody is expecting the worst.I`l
be buying bigtime if we get a market correction.Those that buy then get the last
I been saying it and all the Obama piss-ants, think that everything in this country is just rosey!! With Obama's unpayable debt, the devaluation of the dollar and the inflation starting to infiltrate our economy ..... we are headed for a very shakey times. I'm sure many won't get out with anymore than a blanket and a park bench!
R+R ...... it's the only solution.
And Obama is give work visas to illegals to take jobs that should be going to Americans?? WTF?
The next big crash will be driven by the supercomputers; it should be dubbed “the HAL 9000 crash”. Their limited logic is running at light speed and there is no way to reel them in without damaging the market.
The official demise of the dollar was locked into place in 1971 when “Tricky Dick” Nixon completely severed all ties between the dollar and the gold standard. During the decade that followed, the U.S. experienced some of the worst inflation in its history, only matched by today’s U.S. monetary and fiscal irresponsibility.
Ever heard of the Continental?
Wow ! Just the mere mention of markets falling puts investors on the defensive, we're down over 100 pts already. Black Monday in 87' was very different than the collapse in 08'. In 87', things recovered very quickly and since 08', we're still struggling. Today, we have to work harder & longer for the same returns in order to maintain healthy positions in our portfolios. As long as our financial systems remains artificially inflated, we're going to continue to have this 'cloud' hovering over us.
Solution ? Pay down your debt, deleverage yourself/business. While debt is not necessarily bad, mismanagement of it will 'kill' your business.
Histories have shown the crash of fiat economies always begin with a devaluation of the currency followed by its crash.
Since 1913 our US currency has devalued 92%.
Just food for thought.
Copyright © 2014 Microsoft. All rights reserved.
Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.
[BRIEFING.COM] The stock market ended the Thursday session on an upbeat note with blue chips showing relative strength for the second consecutive day. The Dow Jones Industrial Average (+0.4%) and S&P 500 (+0.3%) settled ahead of the Russell 2000 (+0.2%) and the Nasdaq Composite (+0.1%). It is worth mentioning the benchmark index posted its fourth consecutive gain, registering a new record closing high at 1992.38.
Equity indices climbed out of the gate thanks to early strength among ... More
More Market News
|There’s a problem getting this information right now. Please try again later.|
MUST-SEE ON MSN
- Video: Easy DIY smoked meats at home
A charcuterie master shares his process for cold-smoking meat at home.
- Jetpacks about to go mainstream
- Weird things covered by home insurance
- Bing: 70 percent of adults report 'digital eye strain'