October 19th Crash

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October 19th Crash

On August 25th, 1987, the stock market hit a new all-time high.

By October 19th, less than two months later, the S&P 500 was down a whopping 33.2%.

A year’s worth of gains were wiped out in a week of hard selling.

The final day of the crash saw stocks drop 22%.

Ripples of that event can still be felt today.

In fact, it was during my research into what caused the 1987 crash that led to an important discovery – perhaps the most important of my career.

While boneheaded anti-takeover legislation might have been the trigger of the crash, the real culprit was…

…index futures!

You see, index futures cycle between two sets of hands: Smart Money and Dumb Money.

When the Dumb Money is the main buyer, stocks fall faster than a cheetah on roller skates.

The Dumb Money doesn’t have deep pockets to support their trade, and they typically use more margin – a deadly combination.

In August, a couple months before the crash, there is clear evidence inside a government agency's own database that the Smart Money unloaded their index futures positions to the Dumb Money.

Did they have insider information about the upcoming bill to disallow writing off interest on loans to buy out companies?

Possibly.

One thing is certain: The Smart Money dodged a bullet while the Dumb Money got crushed like a bug under Aretha Franklin’s stiletto heels.

But 1987 was just one of many instances where the Smart Money unloaded their positions ahead of a crash.

In 1998 as stocks were making new highs, the Smart Money once again sold, allowing stocks to fall 20%.

Meanwhile, those parked in the safety of long-term U.S. bonds would have seen their portfolio rise over 12%.

In the 2000-2002 bear market, the Smart Money was almost always out of stocks.

And again in 2008, the Smart Money got out before the carnage that wiped out six years of gains.

Ironically, a simple strategy of buying the S&P 500 (using SPY) when the Smart Money is buying, and switching to U.S. bonds (using TLT) beats buying and holding stocks by almost 10X since 1993.

5,650% vs. 643%.

Buying and holding long-term bonds only returns 407% over the same period despite being the longest running bull market in bond history.

Recently, the Smart Money signaled a change.

Are we about to see a 1987 style event even though stocks are at all-time highs?

It wouldn’t be the first time.

Trade smart,

Dan “Prince of Proof” Murphy

Note: If you're looking for an alternative to your current ETF investment strategy, watch this presentation to learn more about monitoring the index futures market.

There was recently abnormal activity in the index futures market that you should know about.

 

 

 

 

 

 

 

 
 
 
Government required disclaimer: The results listed herein are based on hypothetical trades. Plainly speaking, these trades were not actually executed. Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not actually been executed, the results may have under (or over) compensated for the impact, if any, of certain market factors such as lack of liquidity. You may have done better or worse than the results portrayed.