Market Collapsed 23% 38 Years Ago, Would Be 11,000 Points Today

I watched it happen. On October 19, 1987, the Dow Jones Industrial Average tumbled 508 points, which was 22.6%. It fell from 2,246.74 at the open to 1,738.74 at the close on the day known as Black Monday. Such a drop would be just shy of 11,000 points today. The market was actually worse than that when taken over two days. The Dow had dropped almost 5% the Friday before. The anxiety over the weekend between the two was terrific.

Just before the retreat, there was a concern about U.S. trade deficits. Congress had just begun to talk about whether M&A activity had tax rates that were too low. Interest rates had been rising. However, the primary cause was wider. Many traders believed that the market was too expensive. Famous economist Robert Shiller thought, according to the University of Chicago, the explanation for the drop was that “the crash was as much a sociological or psychological phenomenon as an economic one.”

The overvaluation explanation was based on factors that are somewhat like the current market situation. The value of the Dow rose 67% from January 1985 to the middle of 1987. Over our most recent three years, it is up about 57%.

The primary question about whether the market will drop sharply today will not be measured by the Dow. That yardstick is too narrow now. The S&P 500 is a much better metric. And, within the S&P 500, the Magnificent 7 stocks (Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla) are 34% of the entire value of the index.

There are already cracks in the valuations of the seven stocks. This is certainly true of Apple Inc. (NASDAQ: AAPL | AAPL Price Prediction), the price of which is only up 2% this year. This is largely because it does not have a high-end artificial intelligence product, while the valuation of AI-based companies is soaring. Tesla Inc. (NASDAQ: TSLA) has also been a laggard. It is up 9% this year, to some extent because of the political leanings of CEO Elon Musk. Additionally, there is a debate about whether Tesla is a car company or an AI and robotics operation.

At the absolute core of the value of the world’s most valuable stocks is the future of AI. The earnings of Nvidia, Microsoft, Meta, Amazon, and Alphabet are based almost entirely on whether their bets on AI are correct. Each has already said it will spend tens of billions of dollars on AI data centers this year and next. At the core of the value premise today is whether AI is a product people will pay for or one that is given away almost entirely for free.

Early answers about the future of AI will be part of the earnings and forecasts for the third quarter of this year. If these are shaky, the market will rest downward, perhaps by a staggering amount.

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