A Case Of The Black Mondays

Showtime’s comedy mines the markets for middling laughs.

- Joe Weisenthal

Whenever unexpected volatility strikes the market, as it did last December, some investors and pundits blame “the algos” or “the quants” or “the computers” for creating extreme conditions. These claims are never really that satisfying, though, and often end up sounding like a faux-sophisticated way of saying, “I have no idea why stocks are tanking so much, so I’m going to say something that can’t easily be disproven and makes me sound as if I have a deep understanding of market structure.”

Arguably the earliest example of this phenomenon occurred shortly after Oct. 19, 1987—otherwise known as Black Monday—when stocks around the world cratered and the Dow Jones collapsed by a record 22 percent. To put that into context, the next worst plunge was 13 percent, and that was during the crash of 1929. In fact, the next three worst days were all in 1929, on the eve of the Great Depression.

One common explanation for the ’87 crash was portfolio insurance, which was basically an approach to automate the process of hedging and de-risking a portfolio. Thus, the theory goes, as more stocks fell, automated selling created a downward spiral. Despite the appeal of this theory, it’s far from proven and contains many holes.