Guest Author - Guido Deboeck

Twenty years ago on October 19th 1987 the stock market collapsed. It dropped 23% in one day. At the time I was working in the Investment Department of the World Bank, not as a trader but as a technology manager. The technology held up; no glitches that I can recall, but the action on the trading floor was amazing. The Investment Department of the World Bank maintained at that time some 20 billion dollars in mainly government securities from around the world. A small group of people was responsible to invest that “petty cash account” to make sure capital was preserved and a reasonable rate of return was achieved.

On Tuesday morning October 20th, 1987 there was an early morning meeting of all traders, which as the technology manager I was allowed to attend. Nicholas N. was the Chief Trader at that time. After some discussion as to what the stock market collapse of the previous day would imply, Nicolas decided to reverse the investment strategy and drastically shorted the duration of the portfolio. The net result was that huge profits were made that year; Nicolas and his team came out shining. Later that year they asked management for a bonus system (i.e. compensation above the regular salary scheme under which all staff was paid). This bonus scheme was denied to them and as a result many resigned and left the bank right after the end of the fiscal year. The bank restarted training a new team... Nicolas and his team found greener pastures in Wall Street and in overseas banks.

On February 27th, last Tuesday, I recalled those unforgettable moments of 1987. Granted last Tuesday was nothing like the 23% drop of October 19th, 1987, but the actual facts speak for themselves:

The S&P500 dropped by 5% from his high on 02/22; the Nasdaq dropped by 6.3%. The IBD New America index dropped by 8.6% and the IBD 85-85 index dropped by 12% (all based on comparison of the close on 03/02 with the close on 02/22). The weekly performance table you can find in today’s New York Times (NYT 03/04) shows that in the past week
- domestic stock funds dropped on average by 4.6%
- international stock funds dropped on average by 5.6%
- emerging market stock funds dropped on average by 7.3%

Further down the table you find that in the past week the general bond funds average 0.6% up, the Government bond funds average 0.7% up and the long-term government bonds averaged 1.8% up.

Does it really matter what caused the drop in the markets on Tuesday? Was it caused by the rumors in the Chinese stock market; the speech of Greenspan in Hong Kong (who “mused” about the possibility versus the probability of a recession…); the Japanese yen carry trade; the less impressive economic figures (housing starts, durable orders etc)? Who cares what caused it, without quick action you lost money, and remain at risk of losing even more, if the new market direction is ignored.

TV pundits (and even some professionals in Wall Street) have since Tuesday tried to convince you and me that “a correction is healthy”, that it was “long overdue”, that there is “nothing to worry” about because the economy is in good shape! It is easy for Larry K. to tell you so, but will he share in the pain you may experience IF you do not take a defensive position in the markets? Larry admits he is not a day trader, he is a long-term investor...

Of course, there is the alternative: hope (or even pray as my religious friends sometimes suggest) that what we observed last week in the markets will be merely a blip; come Monday morning there is a major reversal, a jump of at least 5% up to erase all the damage done last week. I sometimes remind my friends that God does not “play the dice (nor the stock market)”.

I found it useful at the end of this week in the markets, to reread segments from the books listed below (especially those on diciplined reacting, on short selling and the like). If these books are not already in your library I suggest you consult them in your local libraries.


03/04/07 11:34 AM 803 words