Lessons from the past: 1987 crash and the GFC
Thirty years after the 1987 sharemarket crash, and 10 years since the global financial crisis savaged world economies, presents a timely opportunity to review lessons from the past. As substantial as both market collapses were, the reassuring fact is that share and financial markets recovered relatively quickly both times.
While investors suffered all the losses in the 1987 crash, the GFC resulted in large costs for many governments forced to outlay huge amounts to ensure the survival of financial institutions and, in the case of the US, mortgage and other insurance companies. Even today, several governments retain ownership stakes in companies they were forced, or chose, to assist.
The 1987 sharemarket crash was a totally different situation caused by overvalued booming sharemarkets buoyed by high levels of gearing, even on newly floated speculative investments. In Australia, about three out of four recently floated companies did not survive the crash and investors could sell the higher quality stocks only at depressed prices to obtain cash.
Within two years, the prices of quality companies had returned to pre-crash levels while the more speculative investments continued to flounder. The message for investors was that losses could be avoided by being able to hold quality shares through the downturn.
The crash also highlighted the risks of gearing, especially when interest rates are high as they were then. Gearing to buy speculative investments at the best of times involves considerable risks because of margin calls as share prices decline.
Sharemarkets have also recovered since the global financial crisis but this is in large part due to the decisions forced on central banks to reduce interest rates to historically low levels. Just how sharemarkets will perform if official interest rates rise to more realistic levels remains to be seen.
The demand for shares and other equity investments has been increased by the pressure on retirees and institutions to increase the yields of their portfolios. Clearly, investors, especially those with gearing, need to be aware of the huge role that artificially low interest rates have played in the recovery of asset prices after the GFC.
Even though the cause of the GFC was different from that of the 1987 crash, many of the decision makers during the GFC had not been market participants at the 1987 crash. If they had been, they could well have not been prepared to enter into the heavily geared financial engineering that led to the mortgage market collapse.
At a personal level, apart from being aware of the risks of gearing, both major collapses underline the benefits of owning diversified conservative portfolios with soundly based investments able to survive downturns.