Is Another 'Black Monday' Stock Crash Imminent?

Summary

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WSJ Your Money Briefing

Episode: Is Another 'Black Monday' Stock Crash Imminent?
Date: October 10, 2017
Host: J.R. Whalen
Guest: Mark Hulbert, MarketWatch senior columnist

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Episode Overview

As the 30th anniversary of 1987’s Black Monday—the largest one-day stock market drop in US history—approaches, this episode explores whether a similar crash is looming. Host J.R. Whalen interviews MarketWatch senior columnist Mark Hulbert, who provides a nuanced perspective, cautioning listeners not to fall for doom-and-gloom forecasts or overly complacent optimism. Instead, Hulbert draws on research and historical analysis to assess risk factors, the role of institutional investors, and the limitations of new regulatory measures designed to prevent market crashes.

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Key Discussion Points & Insights

1. Is a Black Monday Repeat Imminent?

• No Extreme is Accurate: Both extreme views—thinking another crash is impossible due to regulations, or expecting one imminently because of a bull market—are exaggerated.
  • “The truth is somewhere in the middle.” (Mark Hulbert, 01:14)
• Perspective on Scale: Today, a 22.6% drop would equal about a 5,100 point decline in the Dow.

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2. Bull Markets and the Probability of a Crash

• Law of Averages Doesn’t Dictate Timing: A long-running bull market doesn’t automatically increase the likelihood of a crash.
• Historical Precedent for Crashes Requires Steeper Gains:
  • Studies suggest a meaningful increase in the probability of a sharp decline only happens after a 100% market increase over two years. Current gains (~32% over two years at the time) don’t meet this threshold.
    • “We’re not even close to the kind of huge run up that, at least historically, has led to an increased probability of a decline.” (Mark Hulbert, 02:12)

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3. Who Drives Market Crashes?

• Institutional Investors Play a Primary Role:
  • Crashes occur when a significant portion of institutional investors decide to exit stocks en masse.
    • “If institutional investors... all want to get out of stocks, more or less at the same time, they will figure out how to get out of stocks regardless of how many trading halts and circuit breakers…” (Mark Hulbert, 03:07)
  • Trading halts or circuit breakers cannot fully prevent coordinated institutional action—they can shift trading to other venues like international exchanges or futures markets.

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4. External Factors & Quantifying Uncertainty

• Measuring Economic and Political Uncertainty:
  • New research (from University of Chicago and Northwestern) uses news algorithms to quantify ‘economic policy uncertainty.’
  • Contrary to public perception, current levels of uncertainty are about average compared to the last 20 years.
    • “It will nevertheless always be the case that we think uncertainty is greater now than in the past… That’s just not the case if you look at these objective measures.” (Mark Hulbert, 04:58)
• Human Psychology Bias: We naturally view the present as more uncertain—memory distorts our perception of past calm.

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5. Frequency and Predictability of Major Crashes

• Statistical Models on Crash Frequency:
  • One model estimates a 1987-scale crash (~22.6% drop) should occur every 150 years, and a 1929-scale crash (~20%+ drop over multiple days) every 27 years on average.
  • However, these averages are based on centuries and do not predict specific timing.
    • “It could be that we’ll have two crashes as bad as 1987 in a 50-year period, or zero in the next 50 years.” (Mark Hulbert, 07:22)
  • *“We will have another crash… but it doesn’t tell you when.”

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6. Regulatory Reforms: Do They Prevent Crashes?

• Evaluating the Impact of Circuit Breakers and Trading Halts:
  • It’s impossible to know if reforms have worked, since there are no alternate realities to compare outcomes.
  • Lack of a crash doesn’t conclusively prove reforms are the reason.
    • "We have regulatory reforms to prevent pink elephants from showing up on Wall Street. And sure enough, there have been no pink elephants. But that doesn’t tell you really what is cause and effect.” (Mark Hulbert, 08:22)
• Long-Term Data Shows Crashes Are Inevitable:
  • Historical models (including data from the London market since the 1600s) align closely with observed crash frequency, suggesting another crash will eventually occur, reforms or not.

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Notable Quotes & Memorable Moments

• On market myths:

  • “Those who think it’ll never happen... are kidding themselves.” (Mark Hulbert, 01:14)
  • “We should never kid ourselves that we can ever prevent a crash from happening.” (Mark Hulbert, 03:07)

• On modeling uncertainty:

  • “We need to be data-driven in our investing because we aren’t necessarily using a reliable basis if we’re basing it on our historical memories.” (Mark Hulbert, 06:41)

• On regulatory reforms:

  • "We have not had a crash like 1987 in the last 30 years. So you could say, well, it worked. On the other hand, you could say we have regulatory reforms to prevent pink elephants from showing up on Wall Street. And sure enough, there have been no pink elephants.” (Mark Hulbert, 08:22)

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Important Timestamps

• [01:14] — Hulbert discusses misconceptions about crash risk and why the truth "is somewhere in the middle."
• [02:12] — Review of historical crash triggers and market performance thresholds.
• [03:07] — The critical role institutional investors play in crashes and limitations of circuit breakers.
• [04:58] — Quantifying uncertainty via news algorithms, and why current uncertainty isn’t historically abnormal.
• [07:22] — Academic research on the statistical frequency of market crashes, and why averages don’t predict timing.
• [08:22] — Skepticism about the true effectiveness of post-1987 regulatory reforms.

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Summary Takeaways

• Doomsaying and complacency are both misguided.
• Historical data shows big market crashes are rare but inevitable.
• Human psychology consistently misjudges the present as uniquely risky.
• Institutional investor behavior, not just regulations or uncertainty, drives market crashes.
• Data-driven, long-term strategies outperform gut reactions to rare but dramatic market events.

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For listeners: This episode encourages a calm, analytical approach to market risk—understanding that while history teaches us crashes are part of the game, the timing and triggers are largely unpredictable, and most popular explanations (or reassurances) are oversimplified.

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Transcript

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[J.R. Whalen]

this is yous Money Matters from the Wall Street Journal. Welcome to youo Money Matters. I'm J.R. whalen in New York. We're about to hit the 30th anniversary of Wall Street' Black Monday. That was when on October 19, 1987, the Dow Jones Industrial Average fell 22.6% in one day, the worst one day drop in market history. And as that day approaches, we're likely to hear as much commentary suggesting a stock market crash is imminent, giving the market steep run up as we are to hear that a crash is unlikely. Market Watch senior columnist Mark Holbert says don't buy into either extreme and he joins us to discuss. So mark, if a 22.6% drop in the Dow were to happen these days, that would amount to a R roughly 5,100 point decline. Now, you write in the Wall Street Journal that another crash being imminent isn't likely, but also not out of the realm of possibilities.

[Mark Holbert]

That's correct. In one hand you might say, you know, it's unremarkable for me to report that the truth is somewhere in the middle, but in this case, it really is. The truth is somewhere in the middle. Almost everyone will exaggerate what the impact of that crash would have for investors today. Those who think that it'll never happen because of regulatory changes and so forth, like circuit breakers and trading halts and that sort of thing are kidding themselves. I can go into why in a minute. On the other hand, those who think another one's going to happen right away just because the market has been so strong lately, are no doubt exaggerating how likely it is for another crash. Again, the truth is somewhere in the middle.

[J.R. Whalen]

So we're currently in the second longest bull market in US history. It dates back to March of 2009. And one might think that the law of averages would dictate that the longer we go with substantial decline, the likelihood of that happening increases. But researchers you spoke with, they haven't found that correlation.

[Mark Holbert]

There is at least some sense in which a big run up does increase the risk of a decline, but the run up has to be a lot stronger than what we saw. So, for example, the study that I quote in the in the column in the Journal basically says that you have to have 100% increase over a two year period and in order for there to be a meaningful increase of a big decline over the subsequent two years. So if you look at that as 100% threshold over a 24 month period, we're not even close. I think the last I looked, the market over the last two years is up something like 32%, give or take. So we're not even close to the kind of huge run up that at least historically has led to an increased probability of a decline.

[J.R. Whalen]

And when it comes down to it, a lot of these researchers and the modeling has said that it really comes down to institutional investors that are really in the driver's seat.

[Mark Holbert]

Well, that's right. And that's the reason why we should never kid ourselves that we can ever prevent a crash from happening. The research that I quote, and this is other research that goes into why crashes happen in the first place does point the finger at institutional investors, as you indeed suggested in your question. It turns out that if institutional investors, for whatever reason, it doesn't have to be all of them, but a good percentage of the institutional investors all want to get out of stocks, more or less. At the same time, they will figure out how to get out of stocks regardless of how many trading halts and circuit breakers and other regulatory changes that we think might protect the market. For example, if you're a big institutional investor on Wall street and you want to get out of stocks and for some reason they put a trading halt in the New York Stock Exchange, all you have to do is go trade on the London Exchange, where most of the big traded stocks in this country are also trading. You can also go into the global futures market and sell. So it turns out this notion that somehow we can prevent the market decline by saying, hey, we're going to have a timeout and have everyone sort of go back to their corners, we're just kidding ourselves. If they want to get out, they're going to figure out how to get out.

[J.R. Whalen]

And I want to ask you also about other factors in addition to institutional investors that could play a role in down the line. I'll ask you that in just a moment. We're speaking with MarketWatch senior columnist Mark Holbert about the upcoming 30th anniversary of Black Monday on Wall Street. And you're listening to your Money Matters from the Wall Street Journal. Thanks for listening, everyone. So, Mark, we spoke before the break about institutional investors who could get out of stocks en masse and could drive the market lower. We have a lot of external forces also. At the same time, we have uncertainty in our economy and the political landscape and also a lot of Unfortunate world events as well.

[Mark Holbert]

Well, that's right. Now, it's very, very hard for statisticians to go back through history and try to quantify uncertainty in the way that you talk about. But there has been some very interesting research recently out of the University of Chicago and Northwestern, those two institutions. They have a couple researchers there who have tried to quantify economic policy uncertainty, which reflects geopolitical uncertainty as well as. And they have data going back maybe 20 years. So it's not really as far back in history as you would like. But nonetheless, what they've been able to do is they basically have created algorithms on their computers that go through all the major news feeds and look for certain terms that are related and correlated with uncertainty. And if you look at their index, and in fact, it's called the Economic Policy Uncertainty Index, you do a Google search on that and you can go to their data, which is on the website. It's freely available and it's fascinating. But if you look at the latest data right now, economic policy uncertainty is more or less average if you look back for the last 20 years. Now, this is why data are so important here, because as always, it will nevertheless always be the case that we think uncertainty is greater now than in the past. It's a function of our minds. We'll rewrite history as though the past was more certain than it really was and look at today as being more uncertain than ever before. And that's just not the case if you look at these objective measures of uncertainty. So right now, even though it feels like there's a lot of uncertainty in terms of relationship to history, we're actually more or less average.

[J.R. Whalen]

That's pretty fascinating. It's like time heals all wounds. But these algorithms are proving that to be false.

[Mark Holbert]

Well, that's right, we have. This is where our minds play subjective tricks on ourselves. So I think, you know, if there's one broad lesson that we can learn from this, is that we need to be data driven in our investing because we aren't necessarily using a reliable basis if we're basing it on our historical memories.

[J.R. Whalen]

You know, it was also fascinating in your column in the Journal as you spoke with a professor who has a statistical model that says that crashes along the lines of a 1987 decline should happen on average every 150 years. And a crash along the lines of what happened in 1929 should happen every 27 years on average. But you can't go with that as being the end all law.

[Mark Holbert]

Well, that's right. These are averages over many, many centuries. And so he has derived a very complex mathematical model that he believes predicts the frequency of big crashes. And it's the frequency is calculated as an average over many, many centuries. So it could be that we'll have two crashes as bad as 1987 in a 50 year period, or it could be that we'll have zero in the next 50 years. That model will not allow us to predict what we'll see in any given instance or given period of time. But nonetheless, it does suggest that another crash of 1987's magnitude will inevitably occur. And we're kidding ourselves if we think it will not. But on the other hand, it doesn't tell you when.

[J.R. Whalen]

Now, we spoke earlier about the regulatory reforms put into Place since 1987. Things like the circuit breakers and trading halts. Has that had any success in sort of curbing substantial declines? I know you said that we can't prevent crashes, but has it had any success?

[Mark Holbert]

Well, it's one of those things that I think will be it's impossible for us to ever know. Right. Because it depends on trying to imagine what would have happened had they not been in place. We have not had a crash like 1987 in the last 30 years. So you could say, well, it worked. On the other hand, you could say we have regulatory reforms to prevent pink elephants from showing up on Wall street. And sure enough, there have been no pink elephants. But that doesn't tell you really what is cause and effect. And so it's very, very difficult playing the game of counterfactual history because you just don't have the data to allow you to know. But nonetheless, according to this professor's complex model that he's derived, which actually very closely fits the historical data not just in the US but of other markets around the world, for which we have a surprising amount of data. In fact, we have data going back to the 1600s for the London market. And so you go back and look and you can take any magnitude of the decline that you want and use the model to predict how many crashes or declines of that magnitude will have occurred in. And it is very remarkable how much it closely matches the actual frequency of these declines, which gives us some degree of confidence that the model is probably onto something. And it suggests that we will have another crash even if we don't know when it will happen.

[J.R. Whalen]

Well, Mark, we're lucky to have you to distill it down to understandable terms. That's Mark Holbert, Wall Street Journal. He has a great column in the Wall Street Journal and Market Watch senior columnist Mark, thank you so much for being with us.

[Mark Holbert]

My pleasure.

[J.R. Whalen]

And thank you for listening to your Money Matters. I'm JR Whalen in New York at the Wall Street Journal.

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