Reflections on the Past Year
It has been one year since the weekend that shook the foundations of Wall Street and the global financial system – when Lehman Brothers collapsed, Merrill Lynch vanished as an independent entity and AIG was taken over by the U.S. government.
In light of that, it is important to briefly summarize where we’ve been this year, where we are today, and prospects for the future.
Where we’ve been
It’s now widely understood that we’ve been living through a period for the financial history books. The stunning failure of major financial institutions (Fannie and Freddie, Lehman, AIG, Washington Mutual, and others) in 2008 triggered a series of events that almost resulted in the collapse of the global financial system. The lending markets may have been within days of a total shutdown and only extreme government actions prevented a continued meltdown. But while government intervention averted an all-out economic disaster, it was not enough to prevent the worst recession since the 1930s in terms of length, depth, and levels of unemployment.
In early March (months after the initial shocks last fall) it truly did feel like the world might be coming to an end despite the massive government efforts. Understandably, fear was rampant – and stocks responded to the bad news and uncertainty by hitting their lowest levels in over a decade. In hindsight, the March 9th lows of 676 on the S&P 500 and 6,547 on the Dow Jones Industrial Average coincided with the point of maximum pessimism. It was a great time to buy and a terrible time to sell. (The S&P 500 is up over 60% since the March low!)
Since then, the economy has moved back from the precipice and the equity markets have rallied significantly in anticipation of a recovery in the second half of this year.
Where we are today
Two years ago, the market was characterized by investors’ rampant optimism and appetite for risk. The U.S. equity markets hit a new high in October of 2007 and most concerns about excesses in the economy were dismissed. In contrast, six months ago equity markets were overwhelmed by absolute pessimism and 50% below their prior peaks – there was no sign of hope anywhere.
Today, the equity market is somewhere between those two extremes. It is fairly valued – reflecting both the reality that we avoided a banking collapse and the reality that the economy has contracted significantly and is only now starting to turn up. It is no coincidence that as I write this letter the Dow Jones Industrial Average is once again above 10,000 – a level not seen since before the banks imploded and the economy took a significant turn for the worse one year ago.
The outlook going forward
There is much debate about the nature of this recession and the shape of the recovery. Will it be shaped like a V (a strong rebound), an L (a prolonged slump), or perhaps the dreaded W (a double dip recession)? In an environment such as this, two things matter regarding the future – perception and reality. I believe the perception that the economy is on the mend and our recovery will be a normal V-shaped recovery is reflected in the continued advance of the equity markets.
The reality is unknown, and there are many uncertainties that need to be addressed including: continued de-leveraging, inflation fears, stubbornly high unemployment, huge budget deficits, and a falling dollar.
As different as this recession may seem, the list above (and its mere existence) is actually quite familiar. Every recession has its unique problems and circumstances, but each ultimately leads to recovery. This one will as well. Looking beyond the issues facing the global economy, there are many underlying positives and many reasons to be optimistic both about the economy and future returns for globally diversified investors.