Lessons from the 8 years since the market crash

Dan Kemp, the chief investment officer at Morningstar Investment Management, explains how the financial crisis reinforced the danger of paying attention to short-term economic and market noise and the importance of being independently minded.
By Morningstar Analysts |  27-03-17 | 
 

If an investor had the foresight in March 2009 to predict where we would be today, many would be pleasantly surprised with the progress financial markets have made. To help illustrate the growth we have experienced, we can outline some the headline U.S. numbers – while the population has grown just 5.9% in eight years, the S&P 500 is up 200%. (see graph below).

This has many inherent lessons, but none more than the avoidance of short-term thinking.

Rewind the years

Let’s rewind 10 years to March 2007 momentarily. These were the glory days and the world looked as healthy as ever – although as we now know, this assessment of economic health was grossly inaccurate.

A false sense of prosperity can be illustrated in a myriad of ways, however one of the more comical is to reflect on the March 2007 Monthly Bulletin from the European Central Bank:

“Looking ahead, the medium-term outlook for economic activity remains favourable. The conditions are in place for the euro area economy to grow solidly. As regards the external environment, global economic growth has become more balanced across regions and, while moderating somewhat, remains robust, supported in part by lower oil prices. External conditions thus provide support for euro area exports. Domestic demand in the euro area is also expected to maintain its relatively strong momentum.

"Investment should remain dynamic, benefiting from an extended period of very favourable financing conditions, balance sheet restructuring, accumulated and ongoing strong corporate earnings, and gains in business efficiency. Consumption should also strengthen further over time, in line with developments in real disposable income, as employment conditions continue to improve.

"This outlook is also reflected in the new ECB staff macroeconomic projections. The projections foresee average annual real GDP growth in a range between 2.1% and 2.9% in 2007 and between 1.9% and 2.9% in 2008. In comparison with the December Eurosystem staff projections, the ranges projected for real GDP growth in 2007 and 2008 have been revised upwards, largely reflecting the strength of GDP growth in the second half of 2006 and the lower energy prices, which, if sustained, would have a positive impact on real disposable income.”

Does this sound slightly familiar?

The notion that we place too much emphasis on short-term trends is unequivocally important because it is one of the most common and recurring traits that cause financial market cyclicality. If you are not already very sceptical of short-term projections, maybe the ECB bulletin from the bottom of the market – February 2009 – will also help:

“The uncertainty surrounding the global economic outlook is exceptionally high, especially as financial market volatility has soared. Overall, the risks for growth are clearly on the downside. They relate mainly to the potential for the turmoil in the financial markets to have a more significant impact on the real economy.

"The depth and duration of the global economic downturn will depend crucially on the speed at which the financial crisis can be resolved. Other risks relate to concerns about the emergence and intensification of protectionist pressures and to possible disorderly developments owing to global imbalances”.

Dangers of listening to the market noise

This reinforces both the danger of paying attention to short term economic and market noise and the importance of being independently minded. When faced with such noisy conditions, we need to copy the approach of Odysseus in the Trojan War as he sailed past the island of the sirens. Aware that the song of the sirens was enchanting and liable to cause the destruction of his ship, Odysseus employed two strategies. The first was to fill his sailors’ ears with wax and wrap their heads in fabric to that they could not hear the song.

The second was to have himself tied to the mast so that he could hear the song but not respond. While we are in less peril than Odysseus, listening to the ‘siren song’ of market and economic noise may similarly wreck our ability to reach financial goals. Only by following the example of Odysseus and his crew can we hope to pass unscathed.

Practically, this means being circumspect about what information we consume and how we consume it. In addition, it further reinforces the need to implement behavioural strategies that help us resist responding to short-term news and instead remain focused on long-term outcomes.

dan kemp

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