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A 1987-like market crash could happen again, only this time, it would be faster

  • NYSE floor trader Kenny Polcari was on the floor on Black Monday — Oct. 19, 1987 — when the market crashed.
  • This was before cellphones and the internet, so Kenny didn't have any advance warning about the meltdown that was rippling through Asia and Europe ... until the phone rang at 7:15am.
  • Then it was SELL SELL SELL. There wasn't a buy order in sight. And beads of sweat started to roll down his spine ...
  • Kenny says a crash like that could absolutely happen today — only thanks to technology it would happen a lot more rapidly.
In this Oct. 19, 1987 file photo, traders on the floor of the New York Stock Exchange watch monitors for transactions.
AP
In this Oct. 19, 1987 file photo, traders on the floor of the New York Stock Exchange watch monitors for transactions.

I remember Friday, Oct. 16, 1987: I had a pit in my stomach when I got off the train after work. When I got home, I said to my wife: " I don't know what's wrong, but something just doesn't feel right."

Then, I thought: Hey, what do I know? I'm only 26.

The market had been under increasing pressure for the previous three days — each day, it was a bit worse. The tone. The feel. By Friday - the market closed almost on the lows on heavy volume — leaving a sense of dread as we went into the weekend.

On Sunday evening, I went to bed and put on the 10pm news. As usual, I was sound asleep in minutes, not the least bit aware of what was about to happen in Asia as their trading day was getting started.

When I awoke at 4:30am, I did my usual routine: I caught the 5:30am train, giving me time to pick up a cup of coffee and the morning Wall Street Journal. By this point, the trading day in Asia was over, and the devastation that had wreaked havoc there was now slamming Europe, which would be a few hours into their trading day. Markets were coming unglued.

"Brokers got on the phone with customers who were confirming that they wanted to 'make a sale' down $3 - $4 - $5 dollars….and the beads of sweat started to roll down my spine….."

I'm reading the newspaper but remember, this is before the internet, Facebook and Twitter. The paper would've been put to bed the night before, so I was reading Friday's news, unaware of the market carnage that had unfolded in the past 24 hours.

After a stop at the coffee cart, I arrived at my booth around 7am and began to sort through and organize Friday's tickets in my daily ritual … still unaware of what had happened and what was coming down the pike for us when the market opened.

At 7:15am, the phone rang — very unusual for it to ring that early.

"Hello?" I said.

It was my friend and customer.

"Hey, bro - do you know what's going on?" he asked.

"No. What do you mean?" I replied.

He explained that massive selloff that had rippled through Europe and Asia and told me to get ready because the tsunami was coming and about to slam ashore on Wall Street.

The news quickly permeated the floor and the phones started to ring. Everyone was getting sell orders. Everything was for sale. There were no buy orders. Brokers started to circle the posts earlier than usual to see what was going on. STOCK FOR SALE was all you heard … no buys. The buy side of the specialist book was void of orders. The specialist became the buyer of last resort. Indications were significantly lower than last sale. Brokers got on the phone with customers who were confirming that they wanted to "make a sale" down $3 - $4 - $5 dollars….and the beads of sweat started to roll down my spine…..

Here was the problem: This new risk-management software designed by quants, physicists, academics and engineers — called portfolio insurance. The fact that they sold this product to asset managers around the world was the problem. The fact that this was a one-of-a-kind "emotion free" automated insurance product was THE problem.

You see, over that weekend, this product spit out instructions to every asset manager that bought the product — the instruction was that they needed to sell X percent of their portfolio to protect it. But remember, everyone got the same message — SELL. No one got a buy order. And so the slaughter began.

As markets weakened in Asia, the product spit out new SELL instructions to the Europeans — causing those markets to come under even greater pressure, which caused the product to issue even more dire SELL instructions to the American asset managers. And since this product was "the future of risk management," not one client questioned the validity of the call.

Think about it: Some stocks lost 50 percent of their value that day — stocks like Johnson & Johnson. J&J closed at $95 on Friday and closed at $45 on Monday….I mean it's J&J! They make baby powder and baby oil… are you kidding me? But stocks like J&J are stores of value — they are large, highly capitalized stocks that "can be sold" vs. mid-cap stocks that couldn't be sold. So, asset managers sold names that they could. Think any blue chip, large-cap stock in the list … certainly all of the DOW names were ripe for the picking.

The sense was that no one wanted to question the computer. No one questioned the instruction. No matter how bad it got, no one dared go against the computer. And this was the failure of the human being. And so it got worse and worse … the selling pressure never abated. And, while the Federal Reserve made plenty of money available to the big banks and instructed them to buy stock, it did not stop the bleeding — they came into the market and bought stock and the selling increased and prices kept falling.

I remember Dick Grasso, then president of the New York Stock Exchange (who would a couple of years later become the chairman/CEO) and the "red stripes" (the most senior floor brokers charged with helping to maintain fair and stable markets) huddling over by the ramp with the Fed on the phone. They discussed whether or not they should stop trading. Should they close the market? In the end, the decision was made to let the market go because closing it would only cause more panic.

As the day wore on, the selling picked up and the tension rose. The looks on the faces of the "family-owned" specialist units was one of fear. As the pressure built, the moves became even more dramatic, as the specialist remained the buyer of last resort. Customers were screaming about what they thought prices were based on the tape but the tape was way behind. That meant that customers were seeing prices on the tape that didn't correspond to where stocks were trading - the tape could NOT keep up with the trading. So, while you thought a stock was trading at $50, it was most likely trading at $45 and on its way to $40.

By the time the final bell rang at 4 pm, there was devastation — and, while it was ugly and difficult and costly, we had survived it. This disaster gave birth to what we now know as "circuit breakers" — levels on the Dow or S&P that will trigger a halt in trading for an hour, giving people a chance to re-group and re-assess. Circuit breakers will not stop the market from falling completely but they will at least slow it down a bit.

Can it happen again ... even though we have circuit breakers?

Yes it can.

But, it would be different this time because the speed at which it can happen is mind-boggling. Technology allows for anyone with a computer to access the markets, sending in orders for execution in a fraction of a second. Remember in August 2015, when the Dow dropped 1000 points in the first three minutes of trading?

My sense is that ETFs will be the next debacle for the markets. ETFs have given investors a sense of stability and complacency — passive investing. Well, it's all good when the market is going up … no one cares about a rising market EVER. But, when the products come under pressure at the same time, watch how fast liquidity dries up, leaving a void on the bid side of the market.

I'd like to say it could never happen again. But the truth is, it really could.

Commentary by Kenny Polcari, director of NYSE floor operations at O'Neil Securities. He is also a CNBC contributor, often appearing on "Power Lunch." Follow Kenny on Twitter @kennypolcari and visit him at kennypolcari.com.

Disclosure: The market commentary is the opinion of the author and is based on decades of industry and market experience; however no guarantee is made or implied with respect to these opinions. This commentary is not nor is it intended to be relied upon as authoritative or taken in substitution for the exercise of judgment. The comments noted herein should not be construed as an offer to sell or the solicitation of an offer to buy or sell any financial product, or an official statement or endorsement of O'Neil Securities or its affiliates.

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