A Crisis Less Extraordinary

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 |  Includes: DIA, IWM, QQQ, SPY
by: Eric Parnell, CFA

Summary

It is often said that the financial crisis that was unleashed from July 2007 to March 2009 was a once in a century event.

But upon closer examination, the market shock resulting from the financial crisis was not all that extraordinary.

In fact, it was rather modest in many ways when compared to other major historical bear markets.

And this fact alone may be setting investors up for a far more challenging bear market experience the next time around.

It is often said that the financial crisis that was unleashed from July 2007 to March 2009 was a once in a century event. Some investors even take comfort in this notion with the belief that any future stock bear markets will almost certainly pale in comparison. In short, if one could survive the financial crisis, one can certainly weather what may come in the future. But upon closer examination, the market shock resulting from the financial crisis was not all that extraordinary. In fact, it was rather modest in many ways when compared to other major historical bear markets. Instead, the only thing that has been truly extraordinary this time around has been the policy response. And this fact alone may be setting investors up for a far more challenging bear market experience the next time around.

Second Worst Bear Market In The New Millennium

The bear market sparked by the financial crisis was not even the worst bear market we have experienced since the calendar flipped into the new millennium. In many respects, the bear market associated with the bursting of the technology bubble was worse. This is due to the fact that the magnitude of the decline during both bear markets was effectively the same. But stocks (NYSEARCA:SPY) reached the bottom of the financial crisis bear market in a little less than half the time at 412 trading days by March 2009 versus the more than 700 trading days before stocks reached their final post tech bubble bottom in March 2003.

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Now some might say that what made the financial crisis bear market worse was the sharp magnitude of the declines from October 2008 to March 2009. To this I say nonsense. These two past bear markets moved in complete lockstep for the first 300 trading days. It was not until policy makers allowed Lehman Brothers to fail when the financial crisis bear market deviated to the downside. But the net effect of this outcome was the stock market equivalent of ripping the band-aid off quickly instead of slowly. In short, the Lehman failure delivered stock investors to the bottom much more quickly, which many could argue ended up being a great advantage. For even if policy makers helped rescue Lehman the same way they saved Bear Sterns six months earlier, it still would not have alleviated the rotting mortgage debt problem that was festering in the financial system at the time. Instead, the stock market likely would have continued dying a slow and painful death into the summer of 2010 if not longer. And since policy makers seemingly felt like they screwed up by letting Lehman fail, they have been overcompensating ever since by printing trillions of new currency to support the stock market and the economy, the latter of which has been in vain.

Verdict: Bursting of the tech bubble was worse than the financial crisis for investors.

Great Depression Markets Much Worse

The bear market during the financial crisis was also mild when compared to those during the Great Depression. When matched up against the bear market from 1929 to 1932, the financial crisis market was relatively mild in comparison until the very end and was not even able to catch up to the pace of the Great Depression bear market at its darkest moments. And while the financial crisis bear market ended after 412 trading days, the Great Depression bear market lower for a few more years before finally ended down nearly -90% on a price basis.

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In regards to the bear market that started with policy tightening in 1937 and continued with the increasing spread of geopolitical turmoil that ultimately culminated in World War II, the recent financial crisis bear market seems somewhat tame in comparison. For while the magnitude of the overall decline was effectively the same between these two markets, the duration of the World War II bear market lasted more than three times longer before finally bottoming in April 1942. In other words, it took more than five years then versus less than twenty months today.

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Verdict: Both the Great Depression and early World War II bear markets were worse than the financial crisis for investors

The Real Reason Why Investors Hated Stocks By 1982

Then there is the bear market during the stagflationary 1970s. When examining the stock market during this time period, things really do not look all that bad on the surface. But this is due to the fact that this time period is almost always viewed through nominal numbers. This is why the period from 1974 to 1980 is sometimes cited as one of the longest bull markets, but in reality this time period was anything but that. This is due to the fact that inflation was running wild during the time period from the late 1960s to the early 1980s. So in order to make a relative comparison between the modestly deflationary financial crisis and the super inflationary 1970s, one must examine real returns. And when viewing markets through this lens, we see how tame the financial crisis bear market was in comparison.

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On a real basis, both the bear market from the late 1960s to the early 1980s and the financial crisis bear market were down the same -24% on a real basis over their first 14 months. Over the next six months, the financial crisis market lurched more aggressively to the downside, having fallen by a cumulative -51% on a real basis after 20 months versus a still notable -33% real decline from the 1970s bear. But while the financial crisis bear market called it quits at this point and stocks began rallying aggressively higher, the markets from past bear continued crumbling on a real basis for another 143 months, or nearly 12 years, before finally reaching a bottom on an inflation adjusted basis. And in the end by the summer of 1982, stocks had fallen on a real basis by nearly -63%. So not only was the bear market from the 1970s longer by several times, it was also notably worse on a real returns basis before finally bottoming.

Verdict: The stagflationary bear market from the 1970s was considerably worse than the financial crisis from recent years.

Bottom Line

Why does all of this matter? Because investors should not be lulled into complacency with the thought that the financial crisis was a once in a lifetime event that is not doomed to repeat anytime soon. For in reality, the bear market associated with the financial crisis was not only comparable at worst from a returns perspective, but it lasted only a fraction of the time that other major bear market investors had to endure.

What raises the stakes even further in the current environment is that nearly all of the policy bullets to protect against a weakening economy and sharply correcting stock markets have already been deployed even before the next bear gets started. For unlike in March 2009 when the Fed and other global central banks had the luxury of cranking up the printing presses to flood the financial system with liquidity, such is not at all likely to be the outcome the next time around, as the market may be left to sort things out on its own. This, of course, would not necessarily be a bad thing, as this is how the market cleansing process can finally play itself out in bringing us to the dawn of the next great secular bull market. But investors that are fully allocated in advance of any such day of reckoning stand the risk of sustaining meaningful losses that may not be so easily recovered the next time around.

So while the financial crisis was a certainly a traumatic experience for markets, investors in many respects got away easy during this episode, rescued by a fast move to the bottom and unprecedented policy support to pull it back out. One should not expect the same good fortune the next time around and may be well served by planning in advance for any future bear market instead of waiting until it may be too late.

Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long stocks via the SPLV and XLU as well as selected individual names. I also hold a meaningful allocation to cash at the present time.