The period August to October is a time for anniversaries of financial market crises – the 1929 share crash, the 1974 bear market low, the 1987 share crash, the Emerging market/LTCM crisis in 1998, and of course the worst of the Global Financial Crisis in 2008.
The GFC started in 2007 but it was the collapse of Lehman Brothers on 15 September 2008 and the events around it which saw it turn into a major existential crisis for the global financial system.
Naturally each anniversary begs the question of can it happen again and what are the key lessons. And so it is with the tenth anniversary of the worst of the GFC.
The 7 key lessons for investors from the GFC are as follows:
1: There is always a cycle
Talk of a “great moderation” was all the rage prior to the GFC but the GFC reminded us that long periods of good growth, low inflation and great returns are invariably followed by something going wrong. If returns are too good to be sustainable they probably are.
2: While each cycle is different, markets are pushed to extremes
The asset at the centre of the upswing are overvalued and over-loved at the top, and undervalued and under-loved at the bottom. This provides opportunities for patient contrarian investors to profit from.
3: High returns come with higher risk
While risk may not be apparent for years, at some point when everyone is totally relaxed it turns up with a vengeance as seen in the GFC. Backward-looking measures of volatility are no better than attempting to drive while just looking at the rear-view mirror.
4: Be sceptical of financial engineering or hard-to-understand products
The biggest losses for investors in the GFC were generally in products that relied heavily on financial alchemy purporting to turn junk into AAA investments that no one understood.
5: Avoid too much gearing and gearing or the wrong sort
Gearing is fine when all is well. But it magnifies losses when things reverse and can force the closure of positions at a loss when the lenders lose their confidence and refuse to roll over maturing debt or when a margin call occurs forcing an investor to sell just when they should be buying.
6: The importance of true diversification
While listed property trusts and hedge funds were popular alternatives to low-yielding government bonds prior to the GFC, through the crisis they ran into big trouble (in fact Australian Real Estate Investment Trusts (REITs) fell 79%), whereas government bonds were the star performers. In a crisis, “correlations go to one” – except for true safe havens.
7: The importance of asset allocation
The GFC reminded us that what matters most for your investments is your asset mix – shares, bonds, cash, property, etc. Exposure to particular shares or fund managers is second order.