Revisiting the Global Financial Crisis of 2008 – What can investors learn from the great recession?
A LOOK AT THE UNDERLYING REASONS FOR THE GFC CAUSING WIDESPREAD ECONOMIC DAMAGE WORLDWIDE
With markets in turmoil as the Coronavirus spreads, it’s worth revisiting the Global Financial Crisis that took place between 2007 and 2009. For most investors this was the biggest crisis they had ever faced.
In this post we discuss the causes of bubbles and specifically of the credit crisis. We also look at the underlying reasons for the GFC causing such widespread damage. Finally, we look at the performance of major asset classes and what investors could have done to limit volatility in their portfolios.
What causes major bear markets and recessions?
Most financial crises take place when financial assets are trading at inflated, and often irrational, levels. This can occur for several reasons. Very often, “easy money” contributes to market bubbles. Low interest rates and easy access to credit don’t create the same levels of consumer price inflation they used to. But, they do lead to inflation in asset prices. Very often, low rates and the availability of credit combined with market narratives create bubbles.
Over the last two decades bubbles have been created in internet stocks, real estate (during the GFC), cryptocurrencies and cannabis stocks. These bubbles all shared one thing – a story about how big these industries would be in the future. With cheap money and a good narrative, it doesn’t take much for a trend to develop. The trend is then regarded as proof that the narrative is correct, which attracts more buyers to the market. Bubbles are often driven by retail investors, with encouragement from the financial media.
In short, historical trends are extrapolated and investors are fearful of missing out. There is little consideration for valuations and economic reality. Eventually, one of two things happens. At some point when everyone who is likely to invest has already done so, there will be no more buyers. At this point, any bad news will result in the trend reversing.
Alternatively, news will eventually illustrate how overpriced assets have become. A recent example is the cannabis industry. Twelve months after recreational cannabis was legalised in Canada, it became apparent that the market was a fraction of the size it had been projected at.