"The problem is leverage, clear and simple," was how one journalist summed up developments in financial markets, noting that markets were freezing up, liquidity was lacking and investors had become risk averse.
The onset of recession, a weak US dollar and sinking real estate made for a gloomy combination, wrote another.
The crisis had all the markings of the end of an era, observed a third, suggesting that it would take years to clean up the mess of debt and high-risk products left behind by the sharper operators of Wall Street.
The financial strains were accompanied by political tensions. In the US, the Bush administration was under attack over its handling of the war in Iraq, which had driven up oil prices, and its management of the economy.
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The following quotes were referred to by Jim Parker, Regional Director, DFA Australia Limited, in his monthly commentary piece for the Dimensional Fund Advisors website.
All of those observations Jim referred to were made within a few days of each other in January 1991, more than 17 years ago.
A word of caution before proceeding, I do not want to downplay the seriousness of what is happenning in financial markets around the world. It is a very difficult time for investors (& their financial advisors). However, that being said, the majority of the financial press is feeding on the fear frenzy out there using lots of headlines like plunged, carnage, smashed and the like. Sure things are very tough but their are other viewpoints.
Our approach at A Clear Direction is that investors should be staying the course with their investments especially if they have a long investment timeframe before needing to draw an income from their investments or they have heaps of cash and fixed interest securities to rely on so that they do not need to be selling growth assets. Another absolute key is to be extremely well diversified both across asset classes - cash, fixed interest, Australian shares, international shares and listed property - but also within those asset classes.
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So back to Jim's article. The following is taken directly from Jim Parker's article. It provides a much more positive perspective from which to be considering the current crisis.
At that time (January 1991), the Anglo-Saxon economies of the US, Canada, the UK, Australia and New Zealand were all either in or flirting with recession.
The recession came on the heels of an era of financial excess, as exemplified on Wall Street by the junk bond king Michael Milken and in the movies by Gordon "greed is good" Gekko.
In the US, excessive and imprudent lending for real estate had contributed to the failure of hundreds of community-based 'savings and loans' institutions, triggering a multi-billion dollar government bailout.
In the United Kingdom, consumers who had leveraged themselves heavily to real estate suffered a severe blow when rising interest rates pushed house prices sharply lower, both in real and nominal terms.
In Australia, too, market deregulation had given way to an era of increasingly reckless lending by financial institutions, which until that point had had little experience in managing risky commercial loans.
The consequence in Australia was the failure of a number of major financial institutions, including the state banks of Victoria and South Australia, the Teachers' Credit Union of Western Australia, the Pyramid Building Society, merchant banks Tricontinental, Rothwell's and Spedley's and the Estate Mortgage trust.
Examining the causes of the early 1990s bust in the Anglo-Saxon economies, a Reserve Bank of Australia governor later observed that any boom built on rising asset values and financed by increased borrowing had to end.
At that time, the crisis seemed intractable and insoluble. Journalists and economists talked of systemic breakdown and a global challenge for market capitalism, much as they are now.
Now, while no two market crises are ever the same, it is fair to say there are parallels between today's downturn and the events of early 1990s, particularly in the damage caused by excessive leverage and insufficient oversight by many financial institutions of the risks they were taking on.
For those who lived through that period as investors (or even market commentators), you might recall the sense of doom and gloom and the over-riding fear in the financial markets at that time.
The important point is that markets worked through that period of dislocation and uncertainty to emerge stronger. Indeed, the early '90s recession was followed by a stellar decade for equities, one that would have passed by those who had given up in 1991 and hunkered down in cash.
This is not to predict that today's markets are ripe for a similar Phoenix-like revival, but it is a sage reminder that nothing lasts forever and that if you want the returns available from risk assets, you need to stay in your seat.
The risk of not doing so is highlighted in the tables and chart below. They show the returns over a near three-decade period (Jan, 1980-Aug, 2008) for four broad indices?two of relevance to US investors (the S&P-500 and MSCI EAFE) and two for Australian investors (the S&P/ASX-200 and the MSCI ex-Australia index). All returns are in local currency terms.
You can see in the tables and chart that had you missed the six best individual months in that period, the growth of wealth in a portfolio invested in the S&P-500 would have been half of what it would have been had you stayed invested. The results for the other indices are similar.
Bear in mind that six months represents less than two per cent of the period under study. So you can see how difficult market timing can be.
Market Returns: Jan 1980-Aug 2008 |
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Dimensional Returns program; returns are in local currency terms
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In concluding, I want to stress the importance for each individual investor to consider their personal circumstances and situation. Sure, history might suggest that you should stay invested in growth assets but your emotions and stress levels might be telling you otherwise. If you are troubled by what is happenning to your portfolio the best thing to do is get in contact with a financial advisor you trust.
Regards,
Scott Keefer