In 1987, stocks were fairly valued before they crashed

Thursday marks the 30th anniversary of the 1987 “Black Monday” crash that saw the Dow fall by over 22%, its biggest one-day drop on record.

This anniversary, naturally, has brought about a number of discussions on whether another crash could happen and if markets are prepared for the possibility. And with stocks near the high end of their historical valuation range, some investors are concerned that a “stretched” stock market could see investors feel en masse amid a panic.

High valuations, however, were not really a dominant feature of the markets in 1987.

The 1987 market crash defined Wall Street for a generation of investors.

As Yahoo Finance’s Sam Ro noted on Thursday, the market’s Shiller price/earnings ratio — which captures roughly how much investors are willing to pay for $1 of earnings per share using a 10-year rolling average — was right around its historical average ahead of “Black Monday.”

Stocks weren’t even that expensive relative to history ahead of the “Black Monday” market crash. (Source: multpl.com)

Right now, stocks have only been more expensive ahead of the 1929 market crash and during the tech bubble.

Now, as Warren Buffett, among others, has pointed out, the historically low level of interest rates is supporting the market’s valuation and on a relative basis makes stocks look more attractive than a price-to-earnings multiple might otherwise appear. And in any case it is not the price of stocks that makes markets crash — it is fear.

For technical reasons, an exact repeat of the crash cannot happen; new rules in the stock market make a 22% daily drop in the Dow Jones Industrial Average an impossibility. But as Nobel Prize-winning economist Robert Shiller notes in The New York Times on Thursday, this does not mean that panics have been removed from markets or society.

Shiller cites an erroneous report of gunfire and the ensuing panic that broke out at Los Angeles International Airport in July 2016 as an example of how humans are yet to eradicate panics and surprises and the sorts of spiraling phenomena that create stock market crashes from our society. Our markets, of course, exist in this reality.

Shiller also notes that his research immediately after the crash in ’87 that, “a powerful feedback loop from human to human — not computer to computer — set the market spinning.” It was not one bad earnings report, or one bad data point, or anything happening outside of the market itself.

Since 1987, markets have continued to show that they are fully capable of gripping participants in panics.

Consider the stock market’s two-day nosedive in August 2015 that was seemingly set off by vague fears about the Chinese economy. In October 2014, markets plummeted as the U.S. 10-year Treasury bond fell by its most in history before coming all the way back in just hours.

In May 2010, markets fell almost 10% in just minutes as liquidity seemingly evaporated from the stock market. Regulators ultimately blamed a “spoofing” algorithm gone wrong for the sharp drop.

After the surprise Brexit vote in June 2016, and again after Donald Trump’s surprising win in the U.S. election, stock markets around the world tumbled and then quickly recovered.

Fear moves markets lower and then patience brings investors back to reality. The world did not end on November 8, 2016 and it didn’t end on October 19, 1987.

Questions about whether another crash like 1987 can happen have a clear answer — of course it can. But we won’t know when it’s coming, and even decades later we might not have a clear picture of why.

Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland

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