Crash Remembrances

On Friday over at RealMoney, I posted the following:

David Merkel
1987 Memories
10/19/2007 5:20 PM EDT

I was a young actuary when the crash hit in 1987, one year and change into my career. I did not have any investments at that time, but I had just bought a house with my (then) new wife. Few today remember that the crash of 1987 was the culmination of three separate crashes. In late 1986, the US Dollar hit new lows, amid massive intervention by central banks. In February 2007, I came down with a bad cold that sidelined me for four days. Cuddled up with the WSJ while my wife was at work, I concluded that the bond market was about to fall apart, so we accelerated buying a small home. Two months after we completed the financing, mortgage yields rose by 2% during the bond market meltdown.

The stock market roared on, though. Through August, the market rose, and the earnings yield shrank. Bond yields remained stubbornly high; it was a great time to invest in high quality long bonds, particularly long zero coupon bonds.

The eventual crash in October is no surprise to me today. Equities could not stand the competition from bonds, so the market slumped from August to October, until the pressure of dynamic hedging took over starting on Friday the 16th, selling into a declining market in order to maintain the hedges, and spilling over in a self-reinforcing way on the 19th. For what it is worth, there was a humongous rally in long bonds as people sought safety.

Now, my Mom was buying the day after the crash. This is why she is more professional than most professionals I know. She bought solid companies that would survive bad times. I knew far more people who sold into the panic. As for me, I got a trial subscription to Value Line, and picked six stocks, which I sold too soon for a 20% gain, and didn’t return to direct investment in single equities until 1992. (I used mutual funds.)

Since then, I have been consistent in plying my advantage in picking cheap stocks where the fundamentals are under-discounted. It’s been a good niche for me, maybe it can be of value to you as well.

PS — no bounce today, kinda like October 16th, 1987.

Position: none

Now, should the crash have been bought? Yes, at least in the short run, even without knowing the verdict of history. The difference between stock and bond yields narrowed dramatically, and option implied volatility was making a bold effort to escape earth orbit. Beyond that, fast moves tend to mean revert; slow moves tend to persist.
Now, my knowledge of the markets was rather crude back in 1987, so I never would have caught those then; nor did most commentators at the time. People were too scared to be rational. Even the FOMC blinked, with a neophyte Greenspan, with no serious crisis imminent, thus beginning his career of throwing liquidity at small problems, and leaving the consequences for later.

Well, at least I bought the lows in 2002. That event was similar, but not nearly as short-run severe as 1987, though it had the “strength” of longer duration as a bear market.

Before I close for the evening, I would like to mention that I will have the portfolio reshaping complete on Monday, and watch for it here first. As an aside, there are a lot of cheap small cap shoe retailers, and a lot of cheap general and apparel retailers also. I don’t normally buy retailers, but this time things are too cheap. Expect to see me buy one.