Echoes of Black Monday in meme stock phenomenon

Investment advisor marks anniversary of market crash by remembering how a prospective client at the time fell victim to a sense of infallibility

Echoes of Black Monday in meme stock phenomenon

Tim Morton is a CFA and investment advisor at TD Wealth Private Investment Advice. He brings the stark reality of the 1987 crash vividly back to life by recalling how a potential client was lured by a risky trade.

Before working at TD, I was at another financial services firm, and I remember the day -- It was 2:30 in the afternoon on the sunny October 16, 1987. The stock markets set to close at 4pm and I was looking forward to the weekend. It had been a hectic two weeks. The global stock markets had been taking a pounding, during what had been up to that point in time a very positive year.

The phone rang; a couple were in reception and wished to speak with an advisor on setting up a portfolio with blue-chip stocks. I thought to myself, what a great way to end a difficult week. The prospective investor had recently retired and sought my advice on which well-known U.S. securities it would make sense to purchase. We discussed Coca Cola, General Motors and an assortment of fine companies. There was a good meeting of the minds and he agreed to call me on Monday. Little did I know it was the calm before the storm.

Monday morning opened with the stock markets continuing to be severely strained. By the close, the S&P 500 had dropped 20.5% in the single day of October 19, 1987. It was indeed a Black Monday. There was no call from my prospective investor.

Tuesday morning arrived and after initial difficulty in getting the stock exchanges open, a relative calm settled in. There was a call from reception, the prospective investor had returned much agitated. It turned out that upon saying our goodbyes on the prior Friday, he had noticed the firm's options /commodities operation located down the hall. Why not stop in and ascertain their views on investment opportunities?

The conversation turned to selling Put options on the S&P 500. Substantial premiums would be received by the investor for selling Puts, due to the very high stock market volatility. As a novice investor he really had no idea as to what could possibly go wrong. The S&P 500 had already sold off 12% since reaching an all-time high on August 25th and he felt a bottom had been reached. Unbeknownst to me, he had set up an account with the options specialist and effectively sold the market short. This investor was figuratively picking up pennies in front of a steamroller.

So instead of establishing a portfolio of well-managed companies, he headed to his local bank branch. A visit to his bank manager was now required to raise additional funds to pay for his losses on the options trade. I pondered why a non-professional investor would ever want to receive option premiums while exposing themselves to potentially massive losses?

I can only conclude that it is through a sense of being infallible. I see similar risks being taken currently by meme stock investors. They appear to be unaware of the risk to their capital through the purchase of stocks promoted through social media. The purchase of meme stocks does not require careful balance sheet and earnings statement analysis. Meme stock investors hope to get in early and out with a healthy profit, without a focus on what could go wrong.

With generally unfavourable meme stock valuations, there is little value to fall back upon to protect investors' capital. Rather than seeking quick returns, why not turn the tables and seek greater consistency of return, with a reasonable understanding of the risk taken? Had the prospective client followed through with his original plan, he would have held a quality portfolio through a volatile period. By September 1989, many of the broad-based market indices had regained all the value lost in the 1987 crash.