On '87 crash anniversary, what could end bull?

A trader on the New York Stock Exchange holds his head in October 1987 as stocks were devastated during one of the most frantic days in the exchange's history.
Maria R. Bastone | AFP | Getty Images

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Twenty-eight years ago, the Dow Jones industrial average plunged 23 percent in what remains the largest one-day loss in U.S. stock market history.

The exact cause of "Black Monday" has never been determined, so it is difficult to say whether conditions are developing for a repeat of history.

The Federal Reserve partly blames international volatility spreading to U.S. shores as well as the use of a new product from Wall Street called "portfolio insurance."

Many point to China's stock market crash this summer as reason to worry about another cataclysmic event occurring soon.

Crash-like fear was certainly in the air Monday, Aug. 24, of this year when the Dow fell more than 1,000 points on an intraday basis before recovering.

A week ago, CNBC Pro pointed out how an indicator that's supposed to signal a "Black Swan" moment is at its highest level ever.

And Carl Icahn, arguably the best investor during this bull market, said at the end of last month that there was a "looming catastrophe" ahead because of the Federal Reserve's low-rate policy.

So what else has investors frightened that a violent drop in stocks may occur before the end of the year?

1. Bull market losing its biggest supporter: Buybacks

Citigroup put out a statistic last week that may shock some.

Since 2004, more than $4.5 trillion in U.S. equities was purchased by corporations versus just $160 billion flowing into the market via mutual funds and exchange-traded funds over that same timeframe, according to Citi.

Buyback activity in the first half of 2015 was flat compared to a year ago as company executives slowed — their debt-financed stock buying in anticipation of a rate increase by the Fed.

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Any slowdown in the bull market's golden goose of share repurchases could end this bull market, traders fear.

There's another reason to believe this bull market is built mostly on cheap borrowing.

2. Market liquidity plummeting

Traders said a lack of liquidity was the real cause of the 1987 crash and investors fear similar conditions could be setting up today.

Alan Newman of the Crosscurrents newsletter has a unique measure of market liquidity: mutual fund cash minus margin debt.

The cash stockpile left for investors to put to work has plummeted as borrowing at cheap rates to buy stock (margin debt) has surged, bringing Newman's indicator to an almost negative $300 billion.

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So not only do money managers have no cash left to invest, they are borrowed to the hilt, as well. And as pointed out above, new money from the investing public is not likely to replenish these coffers anytime soon.

"The combination of extremely high margin debt and near-record low cash/asset ratios affords as dangerous an environment as I have ever seen," said Newman in an email for this story.

3. ETF's causing market distortions

There's a belief out there that exchange-traded funds -- with their nearly $3 trillion in assets -- are causing market moves to be exaggerated because they place too many assets in the hands of passive vehicles. An ETF won't step up and buy amid a market crash, its mandate is to just follow whatever an index is doing.

"Liquidity constraints are usually the causation of crashes," wrote Renaissance Macro's Jeff deGraaf, one of the best technical analysts on Wall Street. "Today that conventional channel (through the banks) looks fine, so we need to look outside. The liquidity constraint is with ETFs today in my opinion, and we saw evidence of that in late August."

Traders are especially fearful of a market dislocation occurring because of the rising populartity of leveraged ETFs, which use derivatives to double, and even triple, the returns of certain securities. Last week, Nomura closed three leveraged ETFs that track the Nikkei 225 because they had grown so big that it was impossible to meet their mandates.

DeGraaf is also eyeing the performance of U.S. dollar-denominated debt in emerging markets for signs of contagion risk.

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To be sure, many analysts, including DeGraaf, said that a crash is not their base case scenario.

Mark Newton of Greywolf Execution Partners said, "Crashes typically wouldn't happen with sentiment so subdued like it is now and the recent breadth improvement from the August lows is impressive."

So we may just make it out of October unscathed.

But there's enough bearish forces in place right now that the bull market could end this year an no one would be surprised.

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