Despite doomsday scenarios aplenty, recovery has been the theme in 2009.
Global central banks and governments deployed massive stimulus plans with unprecedented speed, size, and coordination.
Key borrowing costs have fallen from extreme levels, and more generally, M&A activity, equity issuance, and Financials' return to profitability are all signs of systemic health.
Doomsday rhetoric has been replaced by debate over the speed of recovery—a big shift in perspective—one that's telltale of how far we've come since the panic.
September will be remembered with more than one tragic anniversary from this decade. Eight years ago the events of 9/11 changed America and global geopolitics—with a human toll far beyond any financial impact. But in the history of capital markets, a more recent anniversary also warrants reflection—one year has passed since a series of events brought Wall Street, and the global financial system, to the brink.
Stock markets are inherently forward-looking, and that's where investors' focus should be today. However, nearing the one year anniversary of last year's financial panic, it's worth looking back at the past year to glean important insight about where things stand today. Almost exactly one year ago, Wall Street witnessed the failure of Lehman Brothers, the sale of Merrill Lynch to Bank of America, and the government bailout of AIG—each shocking in their own right. This cluster is just a selection of the many unprecedented events in 2008, but is widely regarded as the locus of activity that sparked bona fide panic in capital markets.
Liquidity dried up and fear replaced fundamentals as markets plunged. This was a true, rare panic—one that, particularly at its nadir, priced in a very ugly world looking ahead. For a time, economic Armageddon didn't seem all that implausible. However, like most bear market endings, overly dour sentiment and preference for liquidity overshot reality.(In times like these, folks have no problem believing prices have been too high, but seemingly little ability to recognize prices can go too low—an interesting and persistent behavioral quirk through each bear market cycle. The reverse, of course, is often true at bull finales.)
Unwilling to repeat the mistakes of old (Ben Bernanke is a preeminent Depression scholar), central banks across the globe initiated monetary policy efforts—deploying quantitative easing and liquidity programs—with unprecedented speed, size, and coordination. Governments enacted massive stimulus plans too—again with unprecedented speed, size, and coordination. All these actions have not gone without results.
In the case of capital markets, it's more about what didn't happen than what did—which is a hard thing to measure, but ought to be appreciated. Simply, Doomsday didn't happen. Today capital markets are damaged still, but functioning near "normal" in many respects. Key lending indicators have fallen from extreme levels. The TED spread, a gauge of banks' willingness to lend to each other, peaked at over 460 basis points last October—by this week it was 18 basis points. (The average from 2002 to July 2007 was 11 basis points, and from August 2007 until Lehman's collapse last fall, the average was 68.) The Libor/OIS spread, the gap between Libor (a benchmark for short-term interest rates) and the expected Fed funds rate, reached 366 basis points in early October 2008—this week, it sat just below 15 basis points.
More generally, recent activity in M&A and equity issuance, the repaying of TARP funds, and the Financial sector returning to profitability are signs the system is recovering. Three major M&A deals were announced in the past couple weeks, likely indicating low valuations coupled with increasing credit availability.Equity issuance is accelerating—nearly 80 companies registered to sell equity in the first two weeks of August, making it the busiest period since May 2007. Central banks are discussing winding down "emergency" programs, as demand is slowing. (However, this doesn't mean additional small banks won't fail—a recognized toll of any recession and usually, stubbornly persistent long after recovery has taken hold.)
None of these things are particularly robust or bullish in themselves—but the mere notion they're happening at all speaks to a world that's recovering and moving toward growth.
To wit, yield curves—the basic mechanism by which banks make profits—are steep globally, creating a strong tailwind for lending activity and, ultimately, economic growth. Perhaps most importantly, a new bull market has taken hold. Global stock markets have rallied well over 50% since March 9th lows. As one of the only true leading economic indicators, this bodes well for the future economic outlook.
And the brighter future stocks began reflecting a half year ago is manifesting in economic data now. The world looks poised to return to modest economic growth. A number of Eurozone countries are already posting positive quarterly growth rates, and the rate of decline has slowed considerably in the UK and US. Corporate earnings—of particular importance to stocks—are rebounding and largely surprising to the upside. Encouragingly, most global fiscal stimulus has yet to take hold—even if implemented inefficiently (which is likely), the sheer magnitude of the stimulus will act as a catalyst for growth for years to come.
Stocks already reflect what is widely known and believed—but uncertainties remain. Will stimulus be pulled too quickly? Will bungling Beltway politics hold back growth? Will Financials and hostile political headwinds drag the recovery down? Might consumers pose a new threat? Budget deficits? Unemployment? Inflation? The list goes on (click any of the preceding links for details on each topic). No bull market, let alone a nascent one, is met without trepidation and ample worry. But also typical of new bulls, doomsday rhetoric is slowly being replaced by debate over the speed of recovery—a big shift in perspective, and one that's telltale of how far we've come since the panic.
As we look back on the past year, it's important to learn from the often astonishing events that transpired, but also to focus on what lies ahead. Right now, all signs point to continued recovery and rising stocks.