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Did the Dip in the DJIA Last Week Presage an Upcoming Crash?


On the Silver Anniversary of the October 1987 crash, the Dow dropped 1%. An investor who lived through both shares his notes.

I revisit the events of October 19, 1987 this morning because over the weekend many pundits have conjured up a similar crash sequence for this week, building on last Friday's 205-point tumble. Admittedly there is some correlation to the 1987 fiasco, for as the good folks at the "must have" Bespoke organization write:

While 1987 was a much stronger year for equities, the patterns were similar in both years (see chart below). In each case, the S&P 500 (^GSPC) (INDEXSP:.INX) rallied to start the year, reached a short term peak in the spring, then sold off through early summer, only to rally through the fall. At this point in 1987, however, the S&P 500 had already started to break down. Let's hope that for the sake of stockholders everywhere, the patterns have ceased to track each other.

Bespoke goes on to note:

If there is one key difference between now and 1987, it is valuation. The chart below compares the trailing P/E ratio of the S&P 500 in 1987 versus 2012. In 1987 the P/E ratio of the S&P 500 peaked at an above average valuation of 23.4 just as the market was topping out. Following the crash, the P/E ratio bottomed out at 14.4. This year stocks are far from overvalued and are actually below average (see chart). So far in 2012, the S&P 500's peak valuation was 14.9, which is just half a point above the post-crash valuation in 1987.

Still, I was surprised by last Friday's Fade as stocks finished the week with their biggest single-day decline in four months. Surprised, for as stated in last Wednesday's Morning Tack, "Upside resolutions are often tricky, so we may experience a day or two where the markets stall, and rebuild more internal energy, before we get an upside breakout to new reaction highs."
No positions in stocks mentioned.
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