Why This Isn’t Another 2008

In December of 2008, I went to a new client meeting and made a call: ‘I don’t think we are in a second Great Depression.’

With the benefit of hindsight, that doesn’t seem like much of a prediction, because we know after the fact that gross domestic product (GDP) only fell -4.3 percent during the 2008 global financial crisis, which is small compared to the estimated -15.0 percent decline in US GDP during the Great Depression.

My call today is even less dramatic: I don’t think this market will be as bad as 2008.  Without a doubt, stocks are having a tough time.  The S&P 500 is down -11.7 percent since its peak last May and the MSCI All Country World Index (ACWI), which includes all tradable stocks worldwide, has fallen -17.8 percent (in dollar terms) over the same time period.

That’s pretty rough, but let’s remind ourselves that during the 2008 global financial crisis, which actually started in October 2007 and ended in March 2009, the S&P 500 lost -54.8 percent and the MSCI ACWI fell -58.4 percent.

Although we all know that we should be excited to buy stocks ‘on sale’ and should ‘be greedy when others are fearful’ (two Buffett-isms), it’s natural to worry about additional losses amid bad times.

There is at least one major difference between the 2008 financial crisis and today in my view, which is that the underlying financial system isn’t over-leveraged.

If you think about the origins of the 2008 crisis, it started with consumers taking out too much debt on their homes.  When they couldn’t make their payments and home prices fell, it turned into a problem for the banks who became sharply under-capitalized (or ‘insolvent,’ as economist Nouriel Roubini put it).

The problem was transferred from financial institutions to the government, who, in some respects, was able to ride out the storm.  Although the government earned profits on their bailouts, they are more indebted now than ever.  Indeed, the debt problem in the private sector didn’t go away, it was just transferred to the public sector.

The fact that the debt still exists is undeniably bad and something that is going to haunt the US (and the rest of the world) for some time to come in the form of slower than average GDP growth.

That’s the bad news.  The good news is that the financial system is a lot healthier than it was back in 2008 and consumers aren’t in trouble yet.

To be sure, the energy sector is going to endure some bankruptcies and the high yield (junk) bond market is pricing in a fair amount of defaults, but, at this point, it doesn’t appear like it’s enough to take down the banking system.  The financial sector should be able to absorb the losses this time.  That’s not to say everything is rosy in the financial sector – it isn’t, but the capital and leverage ratios look a lot better now than they did in 2008.

Right now the overall market is absorbing new information, principally from oil prices.  Like every asset, the price of oil is dictated by supply and demand, and even though supply is high thanks to OPEC, investors are worried that demand is also unusually week due to slowing global growth, especially in China.

At this point, though, not many economists seem to think that we’re heading into a recession.  Of the 71 economists that Bloomberg tracks, only one sees a contraction in the coming four quarters.  Most are anchored around 2.5 percent, which is slow but positive.

There appears to be some divergence between Wall Street and Main Street.  I remember the same disconnect when we were emerging from the 2008 financial crisis, but Wall Street was euphoric while the economy was mired in the mud.

Wall Street may be correctly predicting a recession, but it could be a false alarm, it’s hard to say.  As famed economist Paul Samuelson once said, ‘Wall Street indexes predicted nine out of the last five recessions.’

It does seem clear that the volatility will be here for a while – at the very least, oil has to settle down into a narrower trading range.  Then, we’ll have to get through another earnings season and a quarter or two of GDP prints here and abroad.

Hopefully, a few years from now, this prediction will look silly, understated and obvious, like my second Great Depression prediction in 2008.  It wasn’t so obvious at the time, just like what happens from here is difficult to predict.

The thing to keep in mind is that we’ve set your asset allocation policy with these kind of markets in mind and have modeled bad times into your financial plan.  Even though we didn’t predict what’s happening now, we all know that stocks go through hard, money-losing periods.

Fortunately, after markets fall, they turn around and make money again – so far we’ve never had a bear market that we haven’t recovered from and I don’t think the basic tenets of investing have changed.