Transcript
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Jim Cramer (1:51)
Hey, I'm Kramer. Welcome to Mad Money. Welcome to Cramerica. I'll be able to make friends. I'm just trying to make a little money. My job is not just to entertain, but to teach. And I'm telling you I'm going to do a lot of teaching tonight. So call me at 1-800-743-CBC or tweet me at Jim Cramer. Tough days do not last forever, but when they come along, you need to know how to respond. You need a game plan ready so you can figure out what kind of sell off we're dealing with and then react appropriately. Because the early days of decline are never easy to navigate. You need all the help you can get to borrow a line from Tolstoy's fantastic Anna Karenina. All happy rallies are alike. Each sell off is unhappy in its own way. It's true. Bull markets and stocks higher and everyone thinks they're genius participating because it seems so darn easy. Same every time, but big declines much harder. They could be the start of a bear market or maybe something worse. Or they might actually be just a viable glitch that's why tonight we're turning to history to illustrate some of the common qualities of sell offs. So you know what to do the next time the market has an inevitable moment of weakness. Now really, There only been two truly horrifying sell offs since I started investing over four decades ago. The one day crash of 1987 and the rolling crash of 2007 to 2009. That was the financial crisis. Do you want even the COVID crash when the SB lost, SB 500 lost 35% of its value in just over a month. That wasn't nearly as bad as these two, especially when you remember that the market started rebounding almost immediately. So let's deal with the two big ones head on because they make for great examples. 1987 and the financial crisis are actually polar opposites, although the percentage declines really pretty similar. On October 19, 1987, also known as Black Monday, the Dow Jones industrial average fell 508 points or more than 22% in a single session. I was trading that day. And even as the previous week had been one of the worst weeks in market history, Black Monday hit fast and hit hard. It felt there were no buyers to be found. From Dow 2246, where the crash started, to Dow 1738, where at last it ended. That day it kept tumbling right into the close. I remember thinking saved by the bell. Except it felt like there wasn't that much money left to be saved. But what most people don't remember that the week before was horrendous to, the Dow had already plunged from 24 and 82 to 22 and 46. That's nearly a 10% decline. That harsh pullback encouraged bargain hunters, intrepid souls who thought they could flip Monday morning into some strength. You bought Friday, flipped it on Monday, except the strength never showed up and they got badly burned. In fact, weakness continued the next day. You know, that day became known as Terrible Tuesday where the Dow kind of just broke down entirely. The market simply stopped functioning. But you know what, I was there and I was actually able to calculate that bottom. The bottom turned out to be about Dow 1400. That was down another 122 points or about 7% from where we closed on Black Monday. At the end of the day, it was all just I pieced them together one by one and people didn't think it ever went down below Dow 1600. But they were wrong. Then Fed Chairman Alan Greenspan stopped the decline in his tracks when he said he'd provide all the the liquidity necessary to stabilize the market. Now I still remember that green line when it came over your screen. He enlisted multiple firms around Wall street to help put in the bottom. And the market staged a remarkable two day rally that took the Dow up more than 400 points from its lows. It seemed pretty unbelievable at the time. The effects of the crash lasted for just three months when we had a retest that held. But do you know that it took until mid-1989 for the averages return to where they were trading before this big breakdown. The bear market that began In October of 2007, seven was a totally different animal. Dow fell from 14,001 198, 1198. So it's a 14,000. Remember the other was 2000, 14,000 and it didn't bottom until March 6th of 2009 when it landed at a staggering 6,470. We didn't return to that how 2007 level until March of 2013. Why did one sell off end so quickly where the other took six years to unwind? Well, that's the question that defines the two extremes of unhappy sell offs. See Black Monday was a mechanical sell off. The first one I can remember where the averages melted down because of pure market dysfunction. It's instructive to unpack Black Monday because the way it played out was reminiscent of two other crashes. The flash crash of 2010 and its doppelganger in 2015. Both times when the market simply failed to work. Now all three of these started with the S&P 500 futures pitch in Chicago. See Chicago overwhelmed Wall Street. New York where the stocks underneath the futures are traded. Black Monday happened because stock traders didn't understand the power of the futures market back then which could flood the stock market with instant unseen supply. No one was ready for it. These days we accept the futures are worth watching, but it wasn't like it back then because they were relatively new instruments created about five years before the crash and no one knew the power they had. See, the power of the future snuck up on us as they were initially a much smaller market than the stocks of the selves. Because portfolio managers could go in easily and out easily. Though the futures became the most powerful drivers of stock prices, particularly for hedge funds. Even more powerful than the actual performance the underlying companies the stocks are meant to represent underlying corporate earnings used to be mean much more to the day to day action of the stock. The thing is, even with the relatively new impact of futures, Black Monday was highly unusual. We'd had a big run going into crash of 87 it was a remarkable multi year rally with nary a substantial decline and don't I know it. I left Goldman Sachs in 1987 to start my own hedge fund because my returns had been so bountiful for investors the multi year rally in the mid to 80s in the mid to late 80s had created such stupendous gains that a group of clever salespeople started offering big funds what they claim were insurance policies that could lock in gains and stop out losses after their funds had gone up so much. So called portfolio insurance involves something called dynamic hedging where these specialists said they could use futures to ensure that you no longer be exposed to stock market risk say down 5 or 10% or some other number depending on the policy you took out. Yeah, it was like a stop loss these the idea was that these policies would let you sidestep the losses. Of course it's impossible to do that but they had such a great sales pitch people believe them because the stock futures were so novel. In reality though, when the losses all kicked in at once on Black Monday, the portfolio insurance didn't work. If anything the future selling from these insurance policies actually accelerated the decline in the stock market causing massive losses for the poor saps who bought these things. Many of the of the actual clients were wiped out. The people who sold these policies they were Charltons and Mountbanks although history remember them says just really as idiots, not the crooks I thought they were. I lean toward the latter theory because there's no magic trick they can get you returns from investing in the stock market. That much risk? Come on. The two go hand in hand. Don't leave anyone who tells you different. Those people are Charlottes of course at the time we didn't know that the power of the futures could cause a crash. We figured where there's smoke there's fire. If the markets crash then there's going to be something wrong with the economy, right? Simply had to be recession lurking. Stocks couldn't go down on their own. There had to. Otherwise how could the Dow plummet 22% in a single day after falling 10% to week four? I say though it turned out wrong. The economy was strong going in the 87 crash, it was strong coming out of it. There just wasn't any economic correlation with Black Monday at all. It was the interplay between Chicago much more powerful and realized in New York much weaker that set up the conflagration. And when the treasury department examined what happened that day it concluded the futures set off immense selling While some Specialist firms on the floor floor of the exchange and some brokerage houses failed to step up in what known as stabilize the tape. The latter had no duty to stabilize things, but the former were supposed to do so. The treasury found out that many didn't do their jobs. Now, I was fortunate enough to actually be in cash on Black Monday, having liquidated my portfolio early in the previous week because the market act so badly, I don't want a part of it. Now, in retrospect, it did make my career. I look like an true genius, but the truth is I was just frightened of the market and wanted to regroup. I always say, though, it's better to be lucky than good. But discipline can help maximize your luck, which is why we spend so much time teaching you discipline. The CBC Investing Club. So here's the bottom line. Sometimes crashes have nothing to do with the economy. They're caused by the mechanics of the market. Stay tuned for more examples of this kind of decline. And the more serious animal, the Bear Market of 2007, 2009. So you can figure out what to do when they really maul us. Irma in New York. Irma?