In the ‘take no prisoners’ market of 2008, a ‘don’t just do something, stand there!’ approach would not have been the worst investing method.
“May you live in interesting times” is an oft-cited quote of supposed Chinese origin. While its origin is up for debate, few can question its relevance in the capital markets of the past two years. Correlations soaring, liquidity-based selling of unprecedented scale, three and four sigma returns across a host of unrelated assets, all seemed beyond the realm of possibility three years ago. Our theories of efficient markets and normal distributions indicated that these results were possible… but it could not plausibly happen to us. For all practical purposes, this past couple of years has seen the investment equivalent of “Land of the Lost,” the 1970s television show where the heroic “modern” family suddenly find themselves immersed in a world of creatures whose existence was thought impossible—dinosaurs, cavemen, and mythical beasts.
Following what we have termed the Take No Prisoners market of 2008 and early 2009, the Mother of all Recoveries market of 2009 continued in the third quarter. The seven-month rally from the lows at the end of February has been breathtaking. With a gain of 45.8%, it was the best seven months of performance for the S&P 500 Index since 1938. International stocks posted a seven-month total return of 60.0%, the fourth-best such period for the MSCI EAFE Index. But international stocks weren’t alone—it was the best seven-month stretch ever for emerging markets stocks (+86.7% for the MSCI Emerging Markets Index), high-yield bonds (+45.1% for the BarCap US Corporate High Yield), and REITs (+75.1% for the FTSE NAREIT Index). Only long-term Treasuries, the lone double-digit winner of 2008, failed to make the black. Last Christmas, we suggested that 2009 would be an “ABT” (anything but Treasuries) year; we had no idea that this forecast would be so impressively true.
Amidst this remarkable environment, plan sponsors had impressive opportunities to either lock in losses or earn outsized returns. Naturally, most investors did the former, as the pain was too great, the uncertainty too unsettling, or the margin call too contractually binding! Only a few brave souls stepped up and embraced the forward-looking return opportunities embedded in wiped-out asset classes—either through a simple rebalance to policy targets or, for the rare contrarians, a sizable new commitment to risk assets—at the market troughs of November and March. Indeed, the average investor, given the tendency to sell out at the bottom, would have likely been better off sleeping through the entire meltdown and post-crisis rally. In this issue, we examine what the “Rip Van Winkle” investment strategy of buying at the start of 2008 and holding through 2009 tells us about asset allocation, risk premiums, and diversification.
Financial Crisis And Post-Rally Total Returns
What would total returns look like if we combined the crisis of 2008 and the first nine months of 2009? As Table 1 shows, only half of the asset classes were down on a cumulative return basis over this time period.
This period was a true bear market (down more than 20%) only for capitalization-weighted equity indexes, commodities, and REITs (which trade on the same exchanges as stocks). Fixed-income categories, even those with substantial credit exposure, posted reasonable gains. Indeed, long Treasuries led the way with a 14.1% gain, with long investment-grade credit (+13.1%) and emerging market bonds (+12.2%) also well in the black. Likewise, high-yield produced a double-digit positive return with a cumulative gain of 10%.