What about the long lead time between bonds and stocks? It's true that the stock market peak in August 1987 came four months after the bond market collapse that took place in April. It's also true that there was a lot of money to be made in stocks during those four months (provided the trader exited the stock market on time). However, the action in bonds and commodities warned that it was time to be cautious.
Many traditional stock market indicators gave "sell" signals in advance of the October collapse. Negative divergences were evident in many popular oscillators; several mechanical systems flashed "sell" signals; a Dow Theory sell signal was given the week prior to the October crash. The problem was that many technically oriented traders paid little attention to the bearish signals because many of those signals had often proven unreliable during the previous five years. The action in the commodity and bond markets might have suggested giving more credence to the bearish technical warnings in stocks this time around.
Although the rally in the CRB Index and the collapse in the bond market didn't provide a specific timing signal as to when to take long profits in stocks, there's no question that they provided plenty of time for the stock trader to implement a more defensive strategy. By using intermarket analysis to provide a background that suggested this stock rally was not on solid footing, the technical trader could have monitored various stock market technical indicators with the intention of exiting long positions or taking some appropriate defensive action to protect long profits on the first sign of breakdowns or divergences in those technical indicators.
peaked in August along with the stock market. A second rally failure by the dollar in October and its subsequent plunge coincided almost exactly with the stock market selloff. It seems clear that the plunge in the dollar contributed to the weakness in equities.
Consider the sequence of events going into the fall of 1987. Commodity prices had turned sharply higher, fueling fears of renewed inflation. At the same time interest rates began to soar to double digits. The U.S. dollar, which was attempting to end its two-year bear market, suddenly went into a freefall of its own (fueling even more inflation fears). Is it any wonder, then, that the stock market finally ran into trouble? Given all of the bearish activity in the surrounding markets, it's amazing the stock market held up as well as it did for so long. There were plenty of reasons why stocks should have sold off in late 1987. Most of those reasons, however, were visible in the action of the surrounding markets and not necessarily in the stock market itself.
Read More : The Bond Collapse - A Warning For Stocks
