"Black Monday 1987" was played again yesterday, with the global financial market collapsing and buzzwords such as circuit breakers, bear markets, and historical records everywhere.

Both the Nikkei 225 and the TOPIX index have crashed by more than 12%, triggering multiple circuit breakers during trading. Taiwan Stock Market saw its largest percentage drop since 1967, South Korea saw its largest percentage drop since 2008, and the Dow Jones Industrial Average fell over a thousand points along with the S&P, marking the largest two-year drop. Fidelity and other institutions have issued warnings about trading failures.

The last time the global market suffered such a painful baptism was during the stock market crash on October 19, 1987.

At that time, stock markets across Asia plunged, with the Nikkei falling 14.9%, the Hang Seng plunging over 40%, and New Zealand's stock index dropping 60% at one point. The U.S. market also fell into chaos, with the Dow Jones intraday plummeting 22.6% and the S&P 500 index plummeting 30%, causing global stock markets to lose about 1.71 trillion U.S. dollars.

In addition to the similarity in degree of sight, the trigger for the two plunges is also similar, with arbitrage and program trading causing a "big reversal." Taking history as a guide, what will happen next? Will the Fed step in again to "save the markets?"

"Black Monday 1987"

Looking back at the U.S. stock market trend in 1987, on October 14, the U.S government announced that the trade deficit was larger than expected, causing the dollar to depreciate and the market to begin declining.

On Friday, October 16, the U.S. House of Representatives proposed legislation to eliminate certain tax benefits related to financing and mergers and acquisitions, intensifying the decline of the U.S. stock market and setting the stage for the chaos of the following week.

When the market opened on Monday, people panicked as there were far more sellers than buyers in the market. Because the difference was so great, many market makers did not even provide market quotes in the first hour.

The U.S. Securities and Exchange Commission later pointed out that as of 10 a.m., there were still 95 S&P 500 stocks that had not opened for trading, while the Wall Street Journal reported that among the 30 Dow Jones component stocks, 11 were unable to open for trading.

At the same time, as there was a large arbitrage space between stock index futures and stocks, a group of trading institutions carried out arbitrage trading, and as the stock market continued to plummet, a large number of hedging plates further shorted index contracts in the stock index futures market, which in turn continued to push down the stock index.

At the close of trading, the Dow Jones Industrial Average plunged 22.76%, creating its largest drop since 1929.

Before the market opened on Tuesday, October 20, the Fed issued a brief statement:

The Federal Reserve today reaffirmed its willingness to serve as a source of liquidity to support the economic and financial system.

The detonator of the two plunges is similar to that of arbitrage and program trading closure.

Similar to 1987, the "Black Monday" of 2024 was triggered by a perfect storm.

At that time, the U.S. stock market had been in a bull market since 1982, and people believed that it was time for an adjustment. Now, the technology stocks pushed up by the AI boom have also made investors "cold as cicadas."

Secondly, the reverse in group trading was also observed in 1987, when "program trading" was believed to be one of the culprits in the stock market crash, with trading programs in investment portfolios selling stocks, leading to a domino effect.

Recently, part of the reason for the stock market crash has been the narrowing of the interest rate differential between the United States and Japan, which has caused a "reversal of arbitrage trading." The Bank of Japan unexpectedly raised interest rates last week, while the Fed signaled a rate cut after its meeting last week, and a September rate cut by the Fed was almost completely priced in. The popular "sell yen, buy U.S. dollars" arbitrage trade in the foreign exchange market is losing its appeal, and investors are beginning to sell their dollar assets for yen.

At the same time, on Friday preceding the 1987 crash there was also a "triple witching day" -- stock option, stock index futures, and stock index option contracts all expired, leading to severe instability in trading during the last few hours of Friday and continuing into Monday.

Finally, the analysis attributes the sharp decline to "mass hysteria", and investors' herd mentality intensifies the decline every time the market drops.

Will the Federal Reserve take action to "save the market" again?

Taking lessons from history, what action will the Federal Reserve take?

In response to the 1987 stock market crash, the United States took measures such as "emergency rate cuts", setting up a circuit breaker mechanism, and providing liquidity to rescue the market.

In order to slow down the decline in the financial market and prevent the overflow effect on the real economy, the Federal Reserve quickly took action to provide liquidity to the financial system, injecting billions of dollars of funds into the economy through quantitative easing policies.

At the same time, the then Federal Reserve Chairman Greenspan announced an "emergency rate cut of 50 basis points", reducing the federal funds rate from over 7.5% on Monday to around 7% on Tuesday.

In addition, regulatory agencies also introduced circuit breaker mechanisms for the first time to prevent market crashes caused by algorithmic trading. Once there is an abnormal drop or rise in the stock market, trading will be immediately suspended.

How will the big drop end?

Analysis believes that the worst-case scenario may be a repeat of 2008, but this seems unlikely. Although some large U.S. banks collapsed last year due to misplaced bets on government bonds, the banks' leverage ratio is much lower than before, and the banking system is less affected by the liquidity crisis due to private credit bearing most of the risk that banks previously bore. Huge losses are possible, and private funds may also be in trouble, but it takes time, and it will not trigger the same systemic crisis.

The ideal situation is that the excessive volatility of the stock market will gradually subside, as it did in 1987, and will not cause bigger troubles. It is expected that this calming process will be slower than in 1987. AI frenzy may cause further declines in stock prices, even though NVIDIA's stock price has doubled this year despite a 30% drop from its peak in June. But the market is already closer to normal levels, with the Nasdaq 100 index up only 6% this year and the S&P index up less than 9%.

"Bond King" Yardeni believes that:

The danger of a market plunge is that the sell-off may become self-reinforcing and lead to credit contraction. It is conceivable that the closure of these arbitrage trades could evolve into some kind of financial crisis, leading to a recession.

However, he emphasized that his personal prediction is that this result is unlikely to materialize.

Editor/Emily