The S&P 500 bottomed at 666 ten years ago this week. Today we consider what the last decade has meant to investors and what lessons might apply to the future. The tale of the tape since 2009 is mixed, at best. US stocks are well above their 2007 prior-cycle highs, while EAFE and Emerging Market equities are not. Despite that, longer-term returns for the S&P are actually quite poor. On the (sort of) bright side: the Financial Crisis and Great Recession made the Federal Reserve even more beholden to financial asset prices.
Once you reach a certain age in this business, it becomes natural to consider your career in the same way a dendrologist examines tree rings.You can easily spot the lean/fat years for markets through the cross-section of your own experience. For me, the notable rings include:
- Starting full time employment out of college at the old Alliance Capital in 1986, barely a year before the 1987 stock market crash.
- Coming out of business school in 1991 at the tail end of a recession caused by the Iraqi invasion of Kuwait, and finding work at First Boston.
- Sitting on the desk at the old SAC Capital during the peak of the 1990s dot com boom and its subsequent unraveling.
- Parked on the trading desk of a large agency brokerage firm as their strategist, looking into the teeth of the Great Financial Crisis and the S&P 500’s “devil’s low” of 666 on March 9th 2009.
We’re coming up to the 10-year anniversary of that nadir on the S&P 500 this Saturday, so today we will reflect on the last decade and what is says about the world today. Past performance may not be indicative of future results, but what happened from 2009 to 2019 deeply informs the investment climate today.
Three points on this:
#1: Only US equities show positive returns since the prior global equity market peak in 2007; major rest-of-world indices are still in the red, almost 12 years on. The data here:
- The S&P 500 is 80% higher than its old October 2007 high, despite dropping over 50% to its eventual early-2009 lows.
- The MSCI EAFE Index (non-US developed economies) is 25% lower than its October 2007 highs at today’s close. It declined by 59% on a price basis from those 2007 highs to its eventual 2009 lows, but only shows a 6.4% annualized return from then to now. The S&P’s annualized return over the last decade is 14.3%.
- The real shocker is that the MSCI Emerging Markets Index is 24% below its October 2007 highs right now. EM equities fell by 62% from that high to their eventual early-2009 lows, but have compounded at only 7.2% on a price basis since then.
Conclusion: geographic equity diversification has some explaining to do, because any allocation away from US stocks since the old 2007 highs has come at a significant cost. Offshore equity bulls argue for an eventual reversion to the mean for non-US stocks. We would simply ask “When, and why?”
#2. While this is the 10th anniversary of the March 2009 lows, the prior year’s negative 36.6% total return on the S&P 500 casts a still-noticeably shadow on long-term returns.
- From the start of 2009 to the end of 2018 (10 years), the S&P 500 has compounded at an average 13.0% total return.
- But add the 2008 experience into the mix (for a total of 11 years), and the S&P’s CAGR drops to 7.2%.
- Go back 20 years, which includes the 3-year decline for the S&P from 2000 – 2003 (a -37% decline), and the S&P’s total return CAGR from 1999 to 2018 is just 5.5%, and only 3.0% after inflation.
Conclusion: Long run S&P 500 returns have been dreadful, the 10-year comps to the March 2009 lows notwithstanding. When investors see a 5.5% compounded return over 2 decades, they naturally look for low cost products like ETFs and robo-advisors and invest in alternative asset classes like private equity and venture capital. No surprise that those have been the growth stories in investing over the last decade. Drawdowns matter.
#3. The Financial Crisis/Great Recession and the subsequent 10 years cemented central bankers’ positions as the western world’s most important non-democratically elected government officials, but also left them more beholden to capital markets than before.
- Deep recessions always exacerbate political divisions and the more long-lasting the economic decline, the more time it takes to heal those rifts. This means elected governments are less able to respond to both economic shocks and resultant social pressures.
- The Federal Reserve and European Central Bank stepped into this void in the years after 2008, and they remain front and center to this day because there is little political consensus on how to address still-sluggish global growth.
- The problem for central bankers: monetary policy is a blunt tool and affects the real economy with a lag, but it whipsaws financial asset prices in real time. While only about 40% of Americans own stocks (and even fewer Europeans), equity prices can sway both consumer and business confidence. We saw that clearly enough last quarter.
- The other issue: global interest rates are nowhere near their pre-Crisis levels, which means unconventional policymaking (asset purchases, larger central bank balance sheets) is now the new normal.
Conclusion: central bankers were a necessary bulwark against greater economic uncertainty 10 years ago, but the current (and likely near-future) political climate means they will remain in the spotlight.
Let’s sum up this section with a famous, if apocryphal, story about former Chinese premier Zhou Enlai. On a state visit to France in 1972 he was asked about the impact of the French Revolution, presumably to tweak him about the popularity of western democracy. His answer: “Too early to say”.
So as much as this note reflects our best efforts to put the last decade into context, we ultimately side with Zhou’s long timeframe perspective: it is simply too early to say what the last 10 years will ultimately mean. We see its effects everywhere from US politics to European Central Bank policy to global trade negotiations. “Too early to say”, indeed.
Continuing our “10 years since the S&P lows” conversation in this section with a look at 5 economic data points that show how the last decade has developed in the wake of the Great Recession. The upcoming tin/aluminum anniversary (the traditional present for a decade of marriage, so we read) has put us in a retrospective mood…
#1: Long-term Treasury rates are lower now than pre-Crisis, in part due to a meaningful shift in inflation expectations.
- Weird fact: 10-year Treasuries had a higher yield a decade ago today than now. The yield on March 6, 2009 was 2.90%. Today’s close was 2.72%.
- In 5 years before the Great Recession, 10-year Treasury yields traded in a band of 4% to 5%. In the last 5 years (2014 – 2019), the range has been 2% to 3%.
- Part of the reason for these lower yields: inflation expectations show a noticeable drop when comparing pre- and post-Crisis data.
Breakeven levels on 10-year Treasury Inflation Protected Securities consistently implied 2.5% future inflation from 2004 to 2007. Over the last 4 years (2015 – 2019), inflation expectations have hovered between 1.5% and 2.0%. Right now, they sit at 1.95%.
- 10-year TIPS breakeven chart here: https://fred.stlouisfed.org/series/T10YIE
#2: US Federal Debt as a percent of GDP took a step function higher in the aftermath of the Great Recession and never looked back.
- At the start of the recession in Q4 2007, total US debt to GDP stood at 63%. This was actually slightly lower than its peak of 65% in 1995 and well below the trough of 54% in Q2 2001.
- By Q4 2010, Federal debt to GDP stood at 92%.
- It is now 104%, and Congressional Budget Office predictions say it will climb further.
- Chart here: https://fred.stlouisfed.org/series/GFDEGDQ188S
#3: The size of the US Federal Reserve’s balance sheet is also much larger than pre-Crisis levels.
- At the start of 2008, the Fed’s balance sheet totaled $922 billion.
- At the start of 2010 (after the first round of bond buying to stimulate the US economy), it was $2.3 trillion.
- By the start of 2015, it had grown to $4.5 trillion, reflecting the Fed’s second round of stimulus.
- The Fed’s balance sheet today: $3.9 trillion, or 4x where it was pre-Crisis and 2x the levels of exactly a decade ago.
- Chart here: https://fred.stlouisfed.org/series/WALCL
#4: While the overall US labor market is strong, the Great Recession’s impact is still visible among younger college-educated workers.
- Recent graduates (those out of school 5 years or less) typically have an edge in the labor force because of their education and lower cost to employ than an older worker. Historically (at least back to 1990), this has translated into their being hired early in an economic recovery.
- That did not happen post-Crisis. US unemployment peaked in April 2010, but recent grad unemployment topped out in March 2011. Also unlike general employment trends, recent grad unemployment actually rose in 2013.
- The latest data from the NY Fed (December 2018) shows a new anomaly: recent grad unemployment is essentially the same as the population as a whole, at 3.7% versus 3.8%. That has never happened before in the history of the data from 1990 to the present. The “recent grad” advantage appears to be gone.
- Data here: https://www.newyorkfed.org/research/college-labor-market/college-labor-market_unemployment.html
#5: Big moves in the dollar came long after the Great Recession was over.
- In March 2009, the DXY Index stood at 80.42.
- It would drop 4% by July, but then climb by 10% over the next 9 months.
- Five years on from the March 2009 equity market lows, the DXY was at 79.78, essentially unchanged (and with very little volatility) over this time span.
- The big move came from March 2014 to October 2016, with the greenback rallying 28%. It has weakened only modestly – about 5% – since then.
Summing up: some of the Great Recession’s impact was immediate, but most of it took years to play out even as equity markets began to recover.Some of these effects, such as lower long-term interest rates, are generally good for stocks whenever they occur. But most – higher Federal debt levels, large central bank balance sheets, and young grad unemployment – are new to this cycle. These risk factors – and many others we did not have space to mention – are the lasting effects of the events of 10 years ago.