This Time It Is Different: Why August 2011 Is Not September 2008

by: Vince Martin

In the midst of a sharp correction in the markets, with several of the worst days in the broad market since the Lehman-induced financial crisis of 2008, it's important for investors to keep their nerves and avoid panic. Yes, there are economic worries, yes there are fiscal worries and yes there are market worries. A double-dip recession seems all but confirmed, unemployment stays stubbornly above 9 percent and European debt threatens to bring down governments, central banks, and perhaps the entire continental experiment.

But as I keep hearing talking heads discuss the "parallels" to 2008, and watch as the VIX reaches heights not seen since that crisis. I can't help but wonder if investors have forgotten just how terrifying the late 2008 crisis was and just how close we were back then, not just to a stock market collapse (which happened, anyhow), but to a complete financial meltdown that could have literally imperiled the world fiat currency system. Short memories seem to have obscured just how dangerous the financial situation was, but remember:

  • In one weekend (September 13-14), Lehman Brothers goes under and Merrill Lynch is purchased and rescued by Bank of America (NYSE:BAC). Over that terrifying weekend, AIG (NYSE:AIG) teeters, begging the federal government for a $40B bridge loan to maintain operations. The final tally for AIG support from the feds would be more than quadruple that amount. European governments inject $50 billion into money market funds, which are threatened by a massive wave of redemption requests. "You've probably seen more in one day of financial history than we've seen since the great crash of 1929," notes associate director Marcus Droga of Macquarie Private Wealth in the Sydney Morning Herald.
  • The following Thursday, Reserve Primary Money Market Fund liquidates its money market fund after "breaking the buck" on Tuesday due to losses on Lehman Brothers commercial paper. The company faced a "run on the bank" due to overwhelming redemption requests from its clients. Its clients are institutional investors, with a minimum of $10MM positions in the fund, proving that panic had set in across the financial marketplace. The New York Times runs an article with a recommendation that investors diversify across money market funds, which traditionally had been considered nearly risk-free investments. On Friday, the Fed steps in with a $50 billion guarantee for money market funds to quell the hysteria. The New York Post claims it was "almost Armageddon", quoting traders who said that $500 billion of the $4 trillion in money market assets were facing redemption requests, essentially crippling the commercial paper market, and that only a Fed rescue package before the market open on Friday saved the market from a 20-plus percent crash and a new "Black Friday".
  • Despite the prevention of a meltdown in money market funds, the credit markets remain locked up. Less than two weeks later, the CEO of AT&T (NYSE:T) complains about his company's inability to issue commercial paper for durations longer than overnight. "I mean literally it's day-to-day in terms of what our access to the capital markets looks like," Randall Stephenson tells USA Today. The Atlantic's Megan McArdle claims that Wachovia (later bought by Wells Fargo (NYSE:WFC)) had no takers for 2-week paper offered at 30 (yes, thirty) percent yield-to-maturity, and a complete seizure in financial paper looms. It was, of course, fears of such credit unworthiness that led to the runs that doomed Bear Stearns and Lehman Brothers.
  • Fear of any counterparty risk to any financial company threatens the liquidity of the entire financial system. The LIBOR overnight rate, the rate at which banks lend to banks to facilitate the thousands of daily transactions made, spikes to 6 percent. Financial stocks crash and soar with every rumor. State Street is halved in a single day, based solely on rumors of exposure to Lehman Brothers bonds (according to McArdle). Investors stampede into Treasuries, with the three-month and six-month yields dropping below one percent. By December, the four-week Treasury bill, sold at auction, will pay literally nothing. Fear trumps everything, risk is seen in every trade, and the stock market is crushed. The S&P 500 hits an intraday high over 1300 on September 2nd. 15 days later, after the Lehman bankruptcy, it sits 12% lower. Just over 6 months later it has been nearly halved, bottoming at 666 on March 6, 2009 before beginning the recent market recovery.

I could, of course, go on and on, but I think the point has been made. In September 2008, there was legitimate doubt about the viability of the worldwide financial and monetary systems, which touched every company in every segment of the marketplace. Indeed, over nine months from the fourth quarter of 2008, plus the first half of 2009 the S&P 500, cumulatively, lost money. Total earnings over those nine months were negative six dollars per share for the index.

Data from spreadsheets provided weekly by S&P; additional data from the same source is used below.

By contrast, the worries in 2011 are far more mundane, far less pressing, and, dare I say, far less interesting.

The main drivers are now:

  • We're worried about a double dip recession. It doesn't take an economist to understand this fear, nor mounds of statistics to raise the possibility. And while I don't mean to dismiss the economic concerns of tens of millions of my fellow humans, from a stock market point of view, the question is: So what? As I wrote on Friday, corporate America is doing just fine, thank you very much. Profits for the S&P 500 are projected to be between $91 and $98 per share for 2011, depending on the models used. At the end of Q2 (with about 80% of companies reporting, using estimates for the balance), sales are up 10% year-over-year and margins are up 5%. In the twelve months after September 2008, the 500 companies in the index, cumulatively, made $7.51 cents per share. Should earnings for the next twelve months fall 25% from current estimates, the companies that comprise the index would still earn roughly ten times what they did in the year following the 2008 crisis.
  • We are scared of the collapse of the euro and the European debt crisis. Given the vast amount of trade across the Atlantic, this is another reasonable fear. But again, the main effect of even a euro collapse on American stocks would be recessionary, not catastrophic. Worldwide banks are better capitalized, central banks are more prepared, and Spanish, Greek, and even Italian debt are not nearly equivalent to the level of US mortgage debt and related swaps that threatened the system in 2008. US banks appear to have less than one percent exposure to the worst of European debt, which even in a default will return some principal to bondholders, while the total CDS market for European sovereign debt is only $78 billion, according to Morgan Stanley (via the Financial Times). The risk of contagion may hurt bank stocks and may even take down a bank or two, but we are far better prepared to combat a prolonged, widespread crisis then we were three years ago. As far as the larger fate of the EU goes, the euro itself has long been panned by experts as diverse as George Soros and Milton Friedman, and its dissolution may provide long-term benefit at the expense of short-term pain.
  • We're scared of the S&P downgrade. Let's face it, being downgraded by S&P is like being told by a prostitute that she just wants to be friends. It stings, but there are better options out there anyhow like perhaps the investors happy to buy 5-year bonds from the federal government for less than one percent annual interest. And I assume that most of those investors didn't make a two trillion dollar error in their calculations.
  • We're scared of our broken political system. This, of course, was the excuse used by S&P after their $2 trillion error was discovered, that "political brinkmanship" was the true reason for the downgrade. Perhaps the esteemed economists at S&P should take a refresher on game theory. The difference in the most recent debt ceiling debate versus prior ones is not that political discourse is somehow more toxic, but that Republicans, strengthened by (and/or terrified of) freshman Tea Party-linked congressmen, are sincere about fighting debt for the first time in recent memory. Brinkmanship is the hallmark of negotiation; this is true not just for Democrats and Republicans, but the NFL players and owners, GM (NYSE:GM) and the UAW, husband and wives, and parents and children. How many millions of parents have explicitly threatened to leave their children in the middle of a shopping mall? Anyone with a modicum of common sense realizes that the federal government is faced with a litany of hard choices. Yet our pundits for some reason assume that these hard choices should be made over rare steaks and fine wine in the Capitol dining room.

I don't mean to dismiss or make light of the genuine problems; economic, political, and fiscal, that are facing our country and the world. But we have faced these challenges before, and no doubt will again. Short-term trading looks likely to stay volatile, and investors' nerves will be tested by some of the moves, up and down. I personally feel the market has more to move to the downside, though it's a gut feeling based more on my reading of current market psychology than my belief in fundamentals.

My long-term bullishness is based on the fact that those fundamentals are stronger than people realize. It's not only corporate profits, but corporate balance sheets, making all-time records. The overnight LIBOR rate, 6% in September 2008, is now 0.138%. The system, while still unsteady, has stabilized. Liquidity is available, while the strengthening of balance sheets in the corporate world has lessened its demand, and thus the possibility of a catastrophic freeze as happened in late 2008.

It's worth noting that on September 15, 2008, the day after the Lehman bankruptcy, the S&P 500 closed at 1,192.70. It closed Wednesday at 1,120, down about 6% in the almost three years since then; roughly flat, when accounting for dividends. Had you bought into the stock market at the onset of that terrifying crisis, you would have survived. I think now, facing a far less severe set of challenges, investors will have the opportunity to not only survive but thrive.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.