Duck for cover! Banking Crisis!
Clickbait-worthy doomsday predictions appear to be everywhere at the moment. How should a smart investor react to headlines like these? How do we avoid getting burned?
Written by Victoria Kent, Senior Investment Specialist
This information does not take into account your personal objectives, financial situation or needs. You should consider if the relevant investment is appropriate having regard to your own objectives, financial situation and needs.
Clickbait-worthy doomsday predictions appear to be everywhere at the moment. From the economic turmoil caused by the collapse of Silicon Valley Bank to the downfall of Credit Swisse followed by its shotgun marriage to UBS – even the sagest investor can be forgiven for feeling rattled by these recent headlines.
The ABC’s Michael Janda warned:
"the sparks are flying...Like any massive bushfire, a full-blown financial crisis starts with one spark and a small flame that isn't noticed or controlled in time."
How should a smart investor react to headlines like these? How do we avoid getting burned?
In times like these, it's prudent to look how markets performed historically during and after similar economic shocks. We can then draw lessons from the past and let it steer us toward more rational territory.
The Global Financial Crisis (“GFC”) and its lessons
Cast your mind back to 2008 when the United States housing market and subprime mortgage industry collapsed. Banks and other financial institutions, who had invested heavily in these markets, suffered significant losses when borrowers defaulted on their loans.
Given the interwoven nature of our globalised economies, the crisis quickly spread and led to a global credit crunch. This then led to a severe contraction in economic activity, and equity markets took a whack.
To illustrate the extent of these market downturns, let’s take a look at three indexes which all lost more than 50% of their value between October 2007 and March 2009:
The Dow Jones Industrial Average: measures the performance of 30 large, publicly traded companies in the United States. At its lowest point, the Dow Jones was around 6,500 points, down from its peak of around 14,000 points in October 2007.
The S&P 500: measures the performance of 500 large-cap American companies. The S&P 500 also experienced significant declines. At its lowest point, the S&P 500 was around 700 points, down from its peak of around 1,550 points in October 2007.
The ASX 200: the stock market index of the top 200 companies listed on the Australian Securities Exchange (ASX). During the GFC, the ASX200 reached its lowest point around 3,100 points, down from its peak of around 6,800 points in November 2007.
Of course, the banking and financial institutions at the centre of the crisis experienced particularly severe losses (if not outright collapsed). But the ripple effect was felt across most sectors, as the global economic downturn caused a decline in consumer spending, reduced business investment, and unemployment rates rose.
As we know, governments and central banks implemented measures to support equity markets and prevent a complete collapse of the financial system. However, it took several years for equity markets to recover fully, and the effects of the crisis were felt for years, with many investors experiencing long-term losses.
Both the DJIA and S&P 500 took until 2013 to return to pre-crisis levels. The ASX 200 was much slower, returning to its pre-crisis levels in November 2009, more than ten years after the crisis began.
What can we learn from the GFC?
Different markets react to global events differently, as well as different sectors within those markets. Therefore, diversification is crucial. The GFC demonstrated the importance of diversification in an investment portfolio. Investors who had a diversified portfolio across different asset classes, sectors, and geographies were better able to weather the storm.
Other key takeaways:
Avoid over-leveraging: the GFC highlighted the dangers of excessive borrowing and leverage. Investors should avoid taking on too much debt and limit their exposure to high-risk investments.
Keep an eye on liquidity: during the GFC, many investors found themselves stuck in illiquid investments that were difficult to sell. It's important to keep an eye on liquidity and ensure that you have access to your money when you need it.
Focus on quality: the GFC highlighted the importance of focusing on quality when investing. Investors should look for high-quality companies with strong balance sheets, sustainable competitive advantages, and a history of generating consistent earnings and cash flows.
Above all, be patient: the GFC showed markets can be volatile and unpredictable in the short term. Investors should take a long-term view and be patient, sticking to their investment plan even during periods of market turbulence.
Market returns vary widely from year to year, and an “average” year never generates the average return. Historically, the stock market has gone up more years than it has gone down. From 1900 to 2020, the ASX has returned 11.8% per annum including dividends. Over that time, it has had 23 negative years (19%) and 97 positive years of returns.
Remember, there is no rule that you have to be active in the markets.
In our article "how to invest during a recession" we explained that too often investors exit the market at their lows, and then have to buy back in once markets have begun to rally again. As long as you have a high quality portfolio and the patience to sit through an economic downturn, your patience could be rewarded.
Billionaire nonagenarian (and Warren Buffet’s business partner) Charlie Munger once famously scolded:
“If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century … you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations.”
Try and take heart in this harsh reality assessment! Market volatility is inevitable, but over the long term, markets tend to bounce back.
It’s too early to say whether a financial crisis is around the corner. But for now, financial markets are holding.
As terrifying as it may be to see the value wiped from your share portfolio, know that over time these downward bumps tend to be smoothed out. Learn from the GFC by avoiding overleveraging, ensure you are diversified, and keep an eye on quality.
Try to ignore the noise and think of the big picture. Make sure you have a long-term horizon, stay rational, have confidence in your investments and stick to your plan.