The global capital markets seized in September 2008. The global economy and financial markets shuttered to a halt. The ensuing global recession was one for the record books, as is the subsequent and longest running bull market in U.S. equities. Over the past decade, the S&P 500 has not so much surmounted the classic “wall of worry” as much as scaled various peaks of angst and ambivalence.
On the 10th anniversary of the Great Financial Crisis, a new report by Bank of America, U.S. Trust offers some key takeaways from the crisis. One stands out: Never bet against America.
From The Abyss And Back: Some Takeaways On The Ten-Year Anniversary Of The Global Financial Crisis
“If you’re going through hell, keep going.” Winston Churchill
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Over the past decade, the world has done just what Churchill recommended—kept going.
Ten years after the global capital markets seized-or when the “music” famously stopped, pulverizing global capital markets and laying waste to one economy after another— the global economy is in the midst of one of the strongest cyclical upswings of this century. After slumping 5.3% in 2009, the steepest decline of the postwar era, global GDP is expected to top $87 trillion this year, a rise of 45% since 2009 (in nominal U.S. dollars). America’s economy is now 40% larger than in late 2008, when the economy began to crater amid what then Fed Chairman Ben Bernanke would call “one of the worst financial crises in global history, including the Great Depression.”
September 2008 will always hold a special place in financial infamy. Following some early warning signals, it was the month when one of the greatest leveraged booms in economic history blew up; it was the month the global financial system and cross-border interbank lending froze; it was the month the U.S. government put Fannie Mae and Freddie Mac into conservatorship; and it was the month various vulnerable Wall Street firms ceased to exist, notably Lehman Brothers, which filed for bankruptcy on September 15, 2008. From that moment, the crisis was on.
And the pain and tumult wasn’t contained to the U.S. It was global, battering British banks, Russian oil companies, German capital goods manufacturers, Icelandic financial firms, Irish households and various Asian institutions.
There were plenty of signs of stress before September 2008. U.S. housing prices peaked in 2006, for instance, and as the air came out of the housing boom, more and more subprime and unconventional loans became ticking time bombs. Between 1999 and 2003, 70% of new mortgages issued in the U.S. were through conventional government-sponsored enterprises (GSE) like Fannie Mae and Freddie Mac. By 2006, however, 70% of new mortgages were subprime or unconventional loans “destined for securitization not by the GSE, but as private label mortgage-backed securities,” according to Adam Tooze in his new book, “Crashed.”1 While only a fraction of that amount was issued in 2001 ($100 billion), in 2005 and again in 2006, as Tooze notes, some $1 trillion in unconventional mortgages were issued.
Securitization was supposed to spread the risk and prevent a systemic meltdown. But history proved otherwise. The slow-moving financial crisis of 2006–07 became a full-blown train wreck in September 2008. The S&P 500 shed $5.1 trillion in value between September 12, 2008, the last day Lehman Brothers was open for business, and March 9, 2009, when the S&P 500 hit an intra-day low of 666. That equates to a gut-wrenching 54% drop.
Since then, however, the steady upward march of the S&P 500 has been nothing short of remarkable. The major index has not so much surmounted the classic Wall Street “wall of worry” as much as scaled various peaks of angst and ambivalence over the past decade (see Exhibit 1). By grinding ever higher, the current bull market becomes the longest in history, surpassing the October 1990 to March 2000 run.
Some Key Inflection Points Along the Way
The road traveled by the S&P 500 has been anything but smooth. Global growth rebounded smartly in 2010 thanks to coordinated global monetary and fiscal efforts. Thereafter, growth became choppier (less synchronized) and the market performance more saw-toothed. The Eurozone floundered from 2011 to 2013, weighing on market sentiment. In August 2011, the U.S. was stripped of its top credit rating, sending shock waves around the world.
China stumbled in 2015, posting its weakest level of annual real growth (6.9%) in a quarter-century. Decelerating growth, not unexpectedly, dented investor confidence and sunk the global commodity complex.
In 2016, politics tugged on the financial markets. “Brexit,” or the United Kingdom’s vote to leave the European Union, stunned investors in June. More stunning: Donald Trump’s successful run to the White House in November. Yet the improbable, but pro-business, Trump Administration gave the U.S. economy and equities a shot of adrenaline over 2017, elongating the winning streaks of the U.S. economy and U.S. equities. Thanks in part to sweeping U.S. tax reform, U.S. corporate profits surged by an estimated 24% in the first half of this year, providing more rocket fuel for equities, with the S&P 500, after posting 19.4% gains in 2017, rising another 5.4% through mid-August 2018 (price returns).
On balance, the bull market in equities has weathered many storms over the past decade and was greatly aided by ultra-easy policies of the world’s central banks, led by the U.S. Federal Reserve. Liquidity is the oxygen of the financial markets, and to keep the oxygen flowing, the Fed has worked overtime since 2008, implementing some of the most unorthodox and unconventional monetary policies in both its history of the Federal Reserve, and the world’s for that matter.
Through quantitative easing (QE)1, QE2 and QE3, the Fed soaked the world in U.S. dollar liquidity, helping to kick start economic growth at home and abroad. Similarly, it was the Fed’s massive bond-purchasing program— adding $3.6 trillion onto the Fed’s balance sheet—that incentivized investors to dump bonds for higher-yielding equities. How much credit goes to the Fed and super-low interest rates in explaining the bull market in U.S. equities remains unclear and open for debate. Indeed, the great monetary experiment isn’t over yet; however, suffice it to say that an uber-aggressive Fed, by reactivating global cross-border lending in dollars, helped limit and contain the damage wrought by the financial crisis of a decade ago. The Fed’s action, in fact, speaks to one of the lessons of September 2008.
The Multiple Lessons of the Crisis
One lesson of the financial crisis is this: The bigger the problem, the faster the required policy response to contain the collateral damage. Scale and speed matter, and they emerged as the critical difference between the U.S. and Europe. The latter preferred more gradualists and uncoordinated policies in the aftermath of the crisis. Europe was slow to recapitalize its banks; slow to recognize the back-breaking debt levels of Greece, Portugal and Ireland; and slower still to stem the loss of investor confidence as Europe’s debt crisis dragged on.
In the United States, in contrast, the monetary response was wrapped in terms like “big Bazookas” and “shock and awe,” aggressive terms that spoke to the need to act swiftly and decisively.
Another lesson: The U.S. economy remains among the most dynamic and resilient in the world. While super-easy monetary policies have certainly lent support to U.S. equities over the past decade, so too has a U.S. private sector that was quick to slash costs, boost productivity, shed unnecessary assets and restructure debt. U.S. firms frantically reset in the aftermath of the crisis. Others reinvented themselves, with the U.S. energy sector embarking on a shale revolution that would double U.S. oil production in a matter of years. U.S. technology leaders continued to push on the frontiers of e-commerce and all things mobile, creating benefits for both consumers and industry tech leaders.
Against this backdrop, it’s little wonder that nearly ten years on from the financial crisis of 2008, no equity market has provided greater equity returns for investors than the United States (see Exhibit 2). The numbers: between the end of February 2009 and the end of July 2018, the S&P 500 (USD, price terms) has returned 283%, versus 131% returns in China, 94% in Japan, 132% in Germany, 82% in the UK, 11% returns in Brazil, and 103% in France. So lesson two: never bet against the United States, to paraphrase a well-used phrase of Warren Buffet.
A third lesson of the crisis is a bit more sobering and yet to play out: Money can’t buy you love. After spending trillions of dollars in support of numerous industries and millions of households, many governments confront ornery constituents. How else to explain the recent surge in global populism and trade and investment protectionism. Brexit and Trump’s triumph were shocking to the consensus because the global economy was healing. Things were normalizing—until they weren’t. Or until populist candidates across Europe and the United States tapped into the wounds and scars of a population still smarting from the financial crisis of 2008.
Other lessons run the gamut and include the following: The global economy and financial markets are highly interconnected and interdependent; shocks that seem localized can be symptomatic of wider systemic problems; excessive levels of debt can lead to financial collapse if not supported by adequate underlying growth rates; risk can remain mispriced for long periods (the convergence of Eurozone debt spreads pre-crisis is a good example); investors can use new paradigm-type arguments for long periods (for example, “house prices will always rise”) to justify market anomalies that prove incorrect in the end; stocks can be volatile in the short term but tend to outperform over the long run; and finally, diversification can help to insulate from unforeseen shocks.
1 Tooze, A., 2018, Crashed: How a Decade of Financial Crises Changed the World, Penguin Books Ltd., London, 720 p.
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