Lessons for the Next Crisis
By Mark F. Toledo, CFAOctober 5, 2017
Almost most 10 years ago, in early October 2007, the S&P 500 Index reached an all-time high before losing more than half of its value over the next year-and-a-half during the 2008 global financial crisis.
Over the coming weeks and months, you will likely see a stream of retrospectives on what happened with the anniversaries of major crisis-related events, including the 10 year anniversaries of the bank run on Northern Rock and the collapse of Lehman Brothers. Many of these articles will include opinions on how the environment today may be similar or different from the period leading up to the previous crisis.
Drawing useful inferences for the future based on such observations will most likely not prove fruitful, because financial markets have a habit of behaving unpredictably in the short run. More important, capital markets have rewarded investors over the long term. Having an investment approach that you can stick with, especially during tough times, may prepare you for the next crisis and its aftermath.
Benefits of Hindsight
In 2008, the stock market dropped in value by almost half. Being a decade removed from the crisis makes it easier to take the decline in stride. The eventual rebound and subsequent years of double-digit gains have helped in this regard. While the events of the crisis were unfolding, however, a future of this sort looked anything but certain. Headlines such as “Worst Crisis Since ’30s, With No End Yet in Sight,” “Markets in Disarray as Lending Locks Up,” and “For Stocks, Worst Single-Day Drop in Two Decades” were common front-page news. Reading the news, opening statements, or going online to check an account balance created unhealthy anxiety for investors across the world.
While being an investor today (or during any period, for that matter) produces anxiety, the 2008 financial crises created acute feelings of panic and dread. Many investors reacted emotionally to these developments. In the heat of the moment, some decided that they could not tolerate additional declines, so they sold out of stocks. On the other hand, many investors displayed the courage necessary to remain committed to their long-term plan. As a result, their financial assets recovered from the crisis as stock prices rose over the subsequent eight-plus years.
Financial crises represent a severe form of uncertainty about the timing and magnitude of equity returns. Crises followed by subsequent recoveries have occurred throughout financial markets history. Exhibit 1 helps illustrate this point. The exhibit shows the performance of a balanced investment strategy following several crises, including the bankruptcy of Lehman Brothers in September of 2008. Each event is labeled with the month and year that it occurred.
Represents cumulative total returns of a balanced strategy invested on the first day of the following calendar month of the event noted. Balanced Strategy: 12% S&P 500 Index,12% Dimensional US Large Cap Value Index, 6% Dow Jones US Select REIT Index, 6% Dimensional International Marketwide Value Index, 6% Dimensional US Small Cap Index, 6% Dimensional US Small Cap Value Index, 3% Dimensional International Small Cap Index, 3% Dimensional International Small Cap Value Index, 2.4% Dimensional Emerging Markets Small Index, 1.8% Dimensional Emerging Markets Value Index, 1.8% Dimensional Emerging Markets Index, 10% Bloomberg Barclays Treasury Bond Index 1-5 Years, 10% Citigroup World Government Bond Index 1-5 Years (hedged), 10% Citigroup World Government Bond Index 1-3 Years (hedged), 10% BofA Merrill Lynch 1-Year US Treasury Note Index.
Although a globally diversified balanced investment strategy invested at the time of each event would have suffered losses coincident with or immediately following these events, financial markets recovered, as can be seen by the three and five years cumulative returns shown in the exhibit. A long-term perspective, appropriate diversification, and an asset allocation plan that aligns your risk tolerance and goals can help you remain disciplined to ride out the inevitable storms. We help clients work through these issues and counsel them when the future looks darkest to help them achieve their goals.
Conclusion
Investors can usually identify a “crisis of the day” or potential major event looming that could be the catalyst for the next market decline. However, correctly predicting future events and how the market will react to events seldom adds value. Accepting volatility and uncertainty leads to a healthier, more productive experience for investors.
To enjoy the benefit of higher potential returns, investors must be willing to accept increased volatility and uncertainty. The ability to stay with an investment philosophy, even during tough times when other investors succumb to short term fear and abandon their plan, represents a key part of a good long-term investment experience. A well‑thought‑out, transparent investment approach can help you be better prepared to face uncertainty and may improve your ability to stick with a plan to ultimately capture the capital markets long-term returns.
Mark F. Toledo, CFA is a Partner at Chicago Partners Wealth Advisors. He has been a wealth manager for over 35 years and has helped hundreds of individuals and foundations create better wealth management solutions.
1wsj.com/articles/SB122169431617549947.
2washingtonpost.com/wp-dyn/content/article/2008/09/17/AR2008091700707.html.
3nytimes.com/2008/09/30/business/30markets.html.
Important Disclosure Information
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chicago Partners Investment Group LLC (“CP”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CP. Please remember to contact CP, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. CP is neither a law firm nor a certified public accounting firm and no portion of the commentary content should be construed as legal or accounting advice. A copy of the CP’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request.
October 5, 2017
Almost most 10 years ago, in early October 2007, the S&P 500 Index reached an all-time high before losing more than half of its value over the next year-and-a-half during the 2008 global financial crisis.
Over the coming weeks and months, you will likely see a stream of retrospectives on what happened with the anniversaries of major crisis-related events, including the 10 year anniversaries of the bank run on Northern Rock and the collapse of Lehman Brothers. Many of these articles will include opinions on how the environment today may be similar or different from the period leading up to the previous crisis.
Drawing useful inferences for the future based on such observations will most likely not prove fruitful, because financial markets have a habit of behaving unpredictably in the short run. More important, capital markets have rewarded investors over the long term. Having an investment approach that you can stick with, especially during tough times, may prepare you for the next crisis and its aftermath.
Benefits of Hindsight
In 2008, the stock market dropped in value by almost half. Being a decade removed from the crisis makes it easier to take the decline in stride. The eventual rebound and subsequent years of double-digit gains have helped in this regard. While the events of the crisis were unfolding, however, a future of this sort looked anything but certain. Headlines such as “Worst Crisis Since ’30s, With No End Yet in Sight,” “Markets in Disarray as Lending Locks Up,” and “For Stocks, Worst Single-Day Drop in Two Decades” were common front-page news. Reading the news, opening statements, or going online to check an account balance created unhealthy anxiety for investors across the world.
While being an investor today (or during any period, for that matter) produces anxiety, the 2008 financial crises created acute feelings of panic and dread. Many investors reacted emotionally to these developments. In the heat of the moment, some decided that they could not tolerate additional declines, so they sold out of stocks. On the other hand, many investors displayed the courage necessary to remain committed to their long-term plan. As a result, their financial assets recovered from the crisis as stock prices rose over the subsequent eight-plus years.
Financial crises represent a severe form of uncertainty about the timing and magnitude of equity returns. Crises followed by subsequent recoveries have occurred throughout financial markets history. Exhibit 1 helps illustrate this point. The exhibit shows the performance of a balanced investment strategy following several crises, including the bankruptcy of Lehman Brothers in September of 2008. Each event is labeled with the month and year that it occurred.
Represents cumulative total returns of a balanced strategy invested on the first day of the following calendar month of the event noted. Balanced Strategy: 12% S&P 500 Index,12% Dimensional US Large Cap Value Index, 6% Dow Jones US Select REIT Index, 6% Dimensional International Marketwide Value Index, 6% Dimensional US Small Cap Index, 6% Dimensional US Small Cap Value Index, 3% Dimensional International Small Cap Index, 3% Dimensional International Small Cap Value Index, 2.4% Dimensional Emerging Markets Small Index, 1.8% Dimensional Emerging Markets Value Index, 1.8% Dimensional Emerging Markets Index, 10% Bloomberg Barclays Treasury Bond Index 1-5 Years, 10% Citigroup World Government Bond Index 1-5 Years (hedged), 10% Citigroup World Government Bond Index 1-3 Years (hedged), 10% BofA Merrill Lynch 1-Year US Treasury Note Index.
Although a globally diversified balanced investment strategy invested at the time of each event would have suffered losses coincident with or immediately following these events, financial markets recovered, as can be seen by the three and five years cumulative returns shown in the exhibit. A long-term perspective, appropriate diversification, and an asset allocation plan that aligns your risk tolerance and goals can help you remain disciplined to ride out the inevitable storms. We help clients work through these issues and counsel them when the future looks darkest to help them achieve their goals.
Conclusion
Investors can usually identify a “crisis of the day” or potential major event looming that could be the catalyst for the next market decline. However, correctly predicting future events and how the market will react to events seldom adds value. Accepting volatility and uncertainty leads to a healthier, more productive experience for investors.
To enjoy the benefit of higher potential returns, investors must be willing to accept increased volatility and uncertainty. The ability to stay with an investment philosophy, even during tough times when other investors succumb to short term fear and abandon their plan, represents a key part of a good long-term investment experience. A well‑thought‑out, transparent investment approach can help you be better prepared to face uncertainty and may improve your ability to stick with a plan to ultimately capture the capital markets long-term returns.
Mark F. Toledo, CFA is a Partner at Chicago Partners Wealth Advisors. He has been a wealth manager for over 35 years and has helped hundreds of individuals and foundations create better wealth management solutions.
1wsj.com/articles/SB122169431617549947.
2washingtonpost.com/wp-dyn/content/article/2008/09/17/AR2008091700707.html.
3nytimes.com/2008/09/30/business/30markets.html.
Important Disclosure Information
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chicago Partners Investment Group LLC (“CP”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CP. Please remember to contact CP, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. CP is neither a law firm nor a certified public accounting firm and no portion of the commentary content should be construed as legal or accounting advice. A copy of the CP’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request.