Last week, we hit an important milestone in the financial markets — ten years ago, on September 15, 2008, Lehman Brothers filed for bankruptcy. The firm was a Wall Street investment bank mainstay, and after its collapse, the dominoes started to fall.
What precipitated the crisis? The answer is too much debt, specifically mortgage debt that was issued under lax lending standards to borrowers who couldn’t pay it back. Then, these questionable mortgages were packaged into bundles (which purportedly improved their credit quality) and bought and sold by investors in the financial markets. As a result of this bundling process, financial institutions underestimated the riskiness of their mortgage debt holdings. As the underlying mortgages began to default, financial institutions that held these bundled mortgages on their balance sheets (particularly those who had used them as collateral to borrow money) began to face the music.
To be clear, Lehman’s collapse did not cause the crisis — but as you can see from the chart below, it was the inflection point at which the market seemed to notice that something was not right.
The stock market has long since recovered from the depths it reached in March 2009, and today we find ourselves in the longest — though admittedly the slowest — U.S. economic recovery to date with the stock market reaching new highs.
Given the nature of the financial markets, we can expect that there will be another crisis in the future — in the words of someone famous, “history does not repeat itself, but it often rhymes.”2 What are some lessons we can learn from the financial crisis of 2008, before the next one comes along?
1. Markets Recover — Stay Invested
At the height of the crisis, newspapers warned of a recession equivalent to the Great Depression with pictures of traders on Wall Street with their heads in their hands, as many investors saw their portfolios down by 20% or even more — all of which made it difficult to imagine how quickly things would turn around. Just six months later, in March 2009, the market took off in a “V-shaped recovery” that few people saw coming. It took time for portfolio values to recover back to pre-crisis levels, but it happened. A globally diversified index of 60% stocks and 40% bonds has returned over 90% since the Lehman collapse.3
Panicking and selling stocks is tempting when things start to go bad in the market, but trying to stop the short-term pain can cause serious long-term damage. We all know someone who pulled out of the market when it crashed and is still waiting for the right moment to get back in, while missing out on a great period of returns. It is nearly impossible to pinpoint that “right moment” because the stock market can start to recover well before the economic news becomes positive. Even seasoned professionals cannot consistently identify the best moment to buy and sell and, over the long term, they actually lose money in that attempt more often than not.
2. Diversification Is Important — Don’t Dump International Stocks
From the beginning of 2008 to the lowest point of the crisis, the value of U.S. large-cap stocks fell by over 50%. This decline wiped out any gains that an investor had achieved by investing in this segment over the prior decade. Over the 10-year period from January 2000 to December 2009, when U.S. stocks declined by 9%5, international stocks rewarded investors with a +30%6 return.
We recently have been in a period where U.S. stocks are outshining every other market segment, which has many investors questioning their international stock exposure. It’s tempting to make drastic changes based on what is happening in the market today, but it’s important to remember that a long-term portfolio benefits from diversification.
3. Bonds Are a Buffer
Throughout the worst of the crisis, during which stocks suffered double-digit losses, investment-grade bonds held their own and
With recent fears that continued rising rates will create a drag on bond returns, and concerns that higher inflation will erode nominal bond returns, we should not forget the very real stability that bonds can provide and the important role they play in a well-diversified portfolio.
Many of us remember the collapse of Lehman and the ensuing panic that gripped the market, when it seemed like there was no floor to stock market declines. A decade later, the lessons we’ve learned from the crisis provide important insights for maintaining discipline and market exposure in a well-diversified portfolio.
Return data represent past performance and are not indicative of future results. Historical returns of indices do not reflect applicable transaction, management or other applicable fees, the incurrence of which would decrease historical performance results. Index information has been compiled by Wipfli Financial from sources Wipfli Financial deems reliable, but has not been independently verified. Historical performance results for investment indices and/or categories have been provided for general comparison purposes only. Indices are unmanaged. It is not possible to invest directly into an index.