V.6:5 (183-187): Spying the black hole by Carl Wyman

Spying the black hole by Carl Wyman

The stock market spiraled into a black hole on October 19, 1987, hurting investors and destroying many put writers. For most traders the plunge was an incredible concepts which could have warned a trader of a potential shorting opportunity—missed. Why were so few technicians prepared for the crash? Were not some technical indications of an impending market "correction" present? Let' take a look at some of the familiar and maybe not so familiar technical market top. None of these concepts are new. Most were written about and practiced more than 50 years ago.

In August 1987, several factors existed which suggested that the longer-term bull market phase might soon end:

-The bull market celebrated its fifth birthday. This is "old" as bull markets go and would sooner or later be followed by a bear market.

-Historically high P/E ratios and miniscule dividend yields (Figure 1) uggested extreme over-valuation. Periods of extreme over-valuation are rare and temporary. Either earnings and dividends would sharply increase or stock prices would soon drop.

-Monetary tightening preceded most major bear markets since World War I (1962 was an exception). A shift from monetary ease to restraint began in early 1987 as evidenced by a decreasing rate of increase in the money supply. Bond and T-bill prices responded by peaking in early 1987. As bond prices moved down, stock prices continued to advance into August, creating a significant divergence (Figure 2). Such a divergence usually resolves with the stock market following bonds downward.