In the jaws of panic

Published in the Herald Sun, October 2017

Thirty years on, have we learnt the lessons of the 1987 market crash? Karina Barrymore investigates

Forget blaming computer programs, fancy algorithms, insider trading or asset price inflation — the reason share markets crash is because people panic.

According to CommSec chief economist Craig James, financial crashes are plain and simple “human events”.

Thirty years after the world’s biggest share market crash, and after all the smaller ones in between, Mr James says panic is still the biggest enemy.

“Humans will always tend to overreact to negative news rather than positive news — it is the way we are wired,” Mr James says. Panic selling, however, is less likely now, because of improved technology and communication, he says.

In 1987, traders and investors were in limbo for hours, forced to second guess outcomes and rumours.

“Advances in technology mean there is more information available for investors to make more rational decisions,” Mr James says.

“Lack of information, or incomplete information, constrains the ability of investors and policymakers to respond sensibly.”

The global policy reaction to the 2007 credit crunch, which caused the global financial crisis, was also influenced by the lessons of 1987.

The first priority last decade was to stop the panic.

“Central banks have learnt from the GFC about the need for a powerful response to ensure negative momentum doesn’t take hold,” Mr James says.

“In the GFC, it was all about ‘doing whatever it takes’.”

Dale Gillham, an analyst at fund manager Wealth Within, says what often feeds panic is another powerful human characteristic, greed.

Every share market crash has been caused by “excess human greed”, Mr Gillham says.

Often that greed comes hand in hand with higher and higher levels of debt as investors borrow beyond normal limits in the hope of earning higher profits.

“Greed is like a snowball rolling down a slope — the further it goes the bigger it gets,” he says.

“Eventually everyone is in the market and we literally run out of buyers so the market must fall.

“All crashes are caused by the overuse of borrowed funds. The greatest number of loan applications and borrowing occurs shortly before a crash.”

UBS Asset Management managing director Anne Anderson was a treasury analyst for a state government authority when the crash happened and observed closely as the full repercussions slowly revealed themselves.

All financial markets, not just the share market, were on edge, unsure of how they would be affected.

“It was at the beginning of globalisation — the real globalisation of financial markets, “Ms Anderson says.

Eventually, the share crash would flow through to bond markets, housing, the jobs market and household incomes.

“But back in 1987, at the time, it didn’t really hurt a lot of people in the street,” Ms Anderson says.

“The pain was felt by a relatively small number of people. Now however, it would be felt by everyone.

“Almost all Australians have some exposure to the equity market as well as through their superannuation.

If a crash happened again, the immediate impact would be much wider.

“It would frighten people — they would think their wealth had reduced, even if it really hadn’t, but this would flow through to consumer confidence and the wider economy.”

AMP head of investment strategy Shane Oliver says a crash as large as 1987 can never be ruled out, despite improvements in communication and technology.

“While circuit breakers introduced after the 1987 crash are designed to limit vertical falls, the growth of high-frequency trading, exchange-traded funds and, possibly, investment programs driven by artificial intelligence all mean that we can’t rule out another crash like 1987 at some point,” Dr Oliver says.

“We also have to bear in mind that crashes and bear markets are part and parcel of share investing and ultimately the price we pay for higher long-term returns from this asset class, compared to, say, bank deposits.”