Broad equity prices falling to 12-year lows is a rare event. The recent fall in stock prices to 1997 levels has only happened two other times since 1900: April 8, 1932, and Dec. 6, 1974. Both dates represent the market lows (within three months) of the most significant bear markets in U.S. stock market history.
However, just because the stock market reached this level does not mean it will suddenly improve, but it does reflect the uniqueness of the current environment.
In both periods, the U.S. economy bottomed in the next four to nine months.
The credit crisis that started 15 months ago, and which became acute in September of 2008, triggered a domino effect of restricted credit availability, forced liquidation of risk assets and eventually a conservative response by investors, consumers and businesses that slammed the brakes on global economic activity.
Short-term cash instruments, U.S. Treasury bonds and (to some degree) gold became the store houses of value as financial leverage was reduced and risk avoided. As risk assets, such as stocks, have become cheaper, the safety assets have become expensive on a historical basis.
We expect the stock market to trade in a narrow range until there is more faith restored in the global banking system. The recent improvements in the credit markets are less visible to the general public, but offer signs of stability.
Removing or containing derivative assets from bank balance sheets will help restore confidence and allow economic activity to improve.
The last 15 months have reminded us all that it is imperative to maintain a well-diversified portfolio to balance risk and opportunity. Based upon the lessons of the past, the crowded trade in safe investments may hold more market value risk in the future, and the discarded risk assets like common stocks may be approaching a rare 100-year buying opportunity.
