10 Years Later – Can it Happen Again

September 15^th marked an ominous anniversary. Ten years prior, Lehman Brothers declared bankruptcy, sparking a financial crisis that engulfed the global economy.

Lehman’s failure could easily be described as a “systemic event.” That’s financial jargon for an event that triggers severe financial instability and sends shockwaves through the economy.

Economically, we’ve recovered from the downturn. Unemployment is low, and GDP is above pre-crisis levels. Major U.S. market indexes have topped pre-recession highs, but the crisis left an indelible mark on investors. For some, the scars remain.

While today’s bull market pushes higher, some investors fear a repeat. You see it every time the market experiences a correction, or a decline of at least 10%. One day, I believe the memory of the crisis will recede. It may take another downturn that doesn’t lead to severe losses, but I believe it will eventually fade.

Can it happen again?

We cannot unequivocally say “Never.”

Gone are the days when a borrower need only a pulse to obtain a mortgage. OK, that’s a bit of an exaggeration, but I think you understand what I’m trying to convey. Whether you blame it on the banks or blame it on borrowers, too many folks jumped into or were placed into loans they couldn’t afford or didn’t understand.

Today, banks are much better capitalized than in 2007. The major banks have a much bigger cushion to absorb loan losses. And underwriting standards for home loans are more realistic.

During the Fed’s quarterly press conference, Fed Chief Jerome Powell was asked about financial conditions.

Powell, said, “The single biggest thing I think that we learned was the importance of maintaining the stability of the financial system.” It’s something “that was missing” back then.

“We've put in place many, many initiatives to strengthen the financial system through higher capital, and better regulation, more transparency, central clearing, margins on unclear derivatives, all kinds of things like that, which are meant to strengthen the financial system,” Powell said.

These measures won’t prevent another recession, and systemic risks haven’t completely abated, but the financial system is in a much better position to withstand a shock than it was in 2008.

Table 1: Key Index Returns

Source: Wall Street Journal, MSCI.com, MarketWatch, Morningstar

MTD returns: Aug 31, 2018—Sep 28, 2018

YTD returns: Dec 29, 2017— Sep 28, 2018

*Annualized

**in US dollars

Takeaways

It’s not about timing the market. It’s about time in the market, diversification, and the balance between riskier assets (such as stocks) that have long-term potential for appreciation, versus safer, less volatile assets that are less likely to appreciate.

Headlines can create short-term volatility. We saw that earlier this year, and we’ve seen it at various times in recent years. But patient investors who stuck with a disciplined approach were rewarded. Longer term, stocks historically have had an upward bias.

While heading to the safety of cash during volatility may bring short-term comfort, opting for the sidelines can have long-term costs.

Let me repeat a Fidelity study I recently quoted. “Investors who stayed in the markets (during 2008) saw their account balances—which reflected the impact of their investment choices and contributions—grow 147%” between Q4 2008 and the end of 2015.

“That's twice the average 74% return for those who moved out of stocks and into cash during the fourth quarter of 2008 or first quarter of 2009.” Even worse, over 25% who sold out of stocks during that downturn never got back into the market.

Yes, the safety of cash during volatility may bring short-term comfort but opting for the sidelines can have long-term costs.

The opposite is also true. Don’t become overconfident when stocks are surging. Some folks feel an aura of invincibility and are tempted to take on too much risk.

That gets them into trouble, too.