Notes, Views, and the Occasional Provocation November / December 2008  

Financial crises happen with surprising regularity – at least once per decade over the past hundred years. The current crisis is the largest in many investors' adult lives, and the economic news may well get worse in coming months. Nonetheless, if past is prologue, the worst of the broad market declines may well be behind us.

Please do forward this newsletter along to anyone who might be interested.

May you have a happy holiday and a respite from the economic and market turmoil, and here's to a much less interesting 2009.

Warm regards,

Milo Benningfield

Weathering The Storm
Investors have been asked to endure a lot this year – the collapse of major financial institutions, the near meltdown of the credit markets, and the steepest market declines in their lifetimes. more

From the BFA Blog
Several highlights from our new blog at more

BFA Media Quotes
Recent media quotes. more

Weathering The Storm
Investors have been asked to endure a lot this year – the collapse of major financial institutions, the near meltdown of the credit markets, and the steepest market declines in their lifetimes.

Every major asset class except cash and U.S. Treasury bonds has fallen hard:

Year-To-Date Returns – December 15, 2008
Asset Class1 Percentage
Intermediate U.S. Treasury Bonds 11.5
U.S. Large Companies
U.S. Small Companies
International Large Companies
U.S. Real Estate
International Small Companies
Emerging Markets
International Real Estate

The severity of the market declines prompts frequent comparisons to the Great Depression, and, in fact, there are some parallels. For example, during the months of September, October, and November of 1929, the S&P 500 Index fell by 33.1%. For September, October, and November of 2008, the S&P 500 was down 29.6%. The extreme market volatility has also rivaled that of the Depression.

Nevertheless, by any reasonable measure of the economy, most of the comparisons being made between today and the Great Depression are absurd. U.S. unemployment reached 25% by 1933; as of December 5, 2008, unemployment stood at 6.7%. As of October 31st, fifteen banks failed in 2008, versus thousands of failures during the Depression. America was essentially an emerging-market economy back then, and there was little global cooperation among governments and financial institutions as there is today.

Yes, things can always get worse. But it's also true that so far, at least, the current crisis still falls within the broad parameters of previous financial crises. At 6.7%, U.S. unemployment is still lower than the 8.5% unemployment of the 1970's oil shocks and the 10% unemployment during the 1990's savings and loan crisis.

Similarly, as of December 16th, the S&P 500 is down 42% from its most recent high in October 2007. This is similar to the 48% peak-to-trough decline in 1973-'74 and the 45% decline in 2000-'02. In other words, the markets themselves are not in uncharted waters.

The difficulty, of course, is the uncertainty about where things go from here. To paraphrase Tolstoy, each recession is unhappy in its own particular way, and market responses to each recession vary a great deal. Sometimes, as in 2001, stocks drop before, during, and after a recession. Other times, such as 1969-'70, stocks decline before and during the recession, but bounce back tremendously afterwards.

History does provide some comfort, however, since it shows that market returns have always bounced back after major economic shocks and been very favorable after consecutive down years.

Market Returns After Consecutive Down Years (S&P 500 Index)2

History also tells us that markets have a tendency to soar right after the end of a bear market. Standard & Poors estimates that since World War II, "stocks have recouped about a third of their bear market losses in the first 40 days after the market hits bottom."3

For individual portfolios, how long it takes to recover all of their initial balance after a significant decline depends on their specific allocation and the order of returns among the different asset classes in the portfolio. The chart below shows how long it took three different portfolios to recover from their worst 24-month period during the 1973-74 recession and the aftermath of the 2000-'02 tech bust.

Market Recovery Times for Three Portfolios4
Starting Month January 1973 October 2000
Portfolio 24-Month Total Return Recovery Period 24-Month Total Return Recovery Period
S&P 500 Index -37.24% 18 months -41.65% 43 months
Diversified 100% Equity -37.80% 13 months -24.37% 10 months
60% Equity / 40% Cash & Bond -19.09% 4 months -9.60% 8 months

Two lessons are clear:

  • Diversification works over time, if not all the time. There is a stark difference in recovery times between an S&P 500 portfolio and a globally diversified equity portfolio.
  • Adding low-risk fixed income to the 60/40 portfolio has dampened the worst returns and shortened the recovery periods.

As in all market downturns, many investors will pay heavy "tuition" by ignoring these lessons and abandoning sound, long-term investment strategies. In the coming months, it may be particularly difficult to stick with such strategies should the dire economic news continue to crescendo, as many people believe it will. Home foreclosures will likely increase; unemployment percentages may rise; more financial institutions may fall.

As for how the markets will respond, we shall have to wait and see. They may fall further, or they may have already priced in much of the bad news to come. Regardless, for investors with horizons spanning decades, not just years, the best advice for weathering the current crisis comes, fittingly, from the land of our newly elected U.S. President Barack Obama:

It is said an Eastern monarch once charged his wise men to invent him a sentence to be ever in view, and which should be true and appropriate in all times and situations. They presented him the words: 'And this, too, shall pass away.' How much it expresses! How chastening in the hour of pride! How consoling in the depths of affliction!

-- Abraham Lincoln, 1859

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From the BFA Blog
We update our blog at almost weekly. You can access it from the link or by going directly to our website at and clicking on the “Blog” tab in the menu. You can also click on the links below to go directly to recommended posts.

Pundits Capitulating – Are We Nearer To A Market Bottom?
Three prominent, formerly bullish financial columnists each recently turned bearish at the same time, suggesting a possible contrarian indicator.

Was Good Market Timing Skill or Luck?
A video interview with Dartmouth finance professor Kenneth French on the difficulty of persistent market timing.

Warren Buffett Repeats His 1974 Advice: Buy Stocks
Warren Buffett's New York Times op-ed article in mid-October was not the first time he's urged investors to buy stocks. He did it once before, with impeccable timing, during the depths of the 1973-74 recession, just before the markets surged in 1975.

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BFA Media Quotes
The New York Times, December 13, 2008
Milo was quoted in Ron Lieber and Tara Siegel Bernard's article, "Be Smart, but Don’t Think That You're Special." The article responded to the recent Bernard Madoff "Ponzi scheme" scandal and addressed why wealthy investors sometimes hand over money to investment managers without an adequate understanding of the manager's strategy. Milo noted the vulnerability of investors who may be smart, but not educated about investments, stating, "I think a lot of millionaires, maybe they inherited a couple of million or they didn't earn their money through any investment savvy. . . . A lot of those people have money and are extremely vulnerable, in part because they're supposed to be smart because they have money. It's a paradox." Read the article.

BusinessWeek Online, November 25, 2008

Milo was quoted in Ben Steverman's article, "Stocks: The Individual Investor's Dilemma," which addressed how investors have been responding to the market downturn. Milo noted that a lot of people were avoiding big portfolio moves, in part because they "are just frozen," and "are trying to cope, and they're still in shock." He also noted that how so-called "bear market rallies" can wear investors down: "Once they buy in and it crashes to a new low, that's when they walk away in disgust," he says. "I'm trying to prepare clients for even greater disappointments." Read the article.

That's it for now. I hope you have a very good holiday and a Happy New Year. Please look for our next newsletter in February.

Best Regards,

Milo Benningfield

1 Asset classes are represented by the following mutual funds as of 12-15-2008, except where noted: Intermediate U.S. Treasury Bonds, DFA Int Government Fixed Income (DFIGX); Cash, Fidelity Money Market Fund (SPRXX) as of 12-12-2008; Commodities, PIMCO Commodity Real Return Institutional Shares (PCRIX); U.S. Large Companies, Vanguard Total Stock Market ETF (VTI); U.S. Small Companies, DFA US Small Cap Portfolio (DFSTX); Int'l Large Companies, DFA Large Cap Int'l Portfolio (DFALX); U.S. Real Estate, DFA U.S. Real Estate Portfolio (DFREX); Int'l Small Companies, DFA International Small Company Portfolio (DFISX); Emerging Markets: DFA Emerging Markets (DFEMX); Int'l Real Estate, : DFA Int'l Real Estate Securities Portfolio (DFITX).

2 Source: JPMorgan Asset Management. Market returns represented by the S&P 500 Index returns (price only). Returns reflect calendar year returns and not peak to trough. Past performance is not indicative of future results. Data as of 12/31/07.

3 "Forget Logic; Fear Appears to Have Edge," The New York Times, October 7, 2008.

4 Thank you very much to Jay Totten at Dimensional Fund Advisors for suggesting and compiling this data. The "Diversified 100% Equity" portfolio is represented by the DFA Equity Balanced Index Strategy, which is allocated to the following equity asset classes: Composition: 20% US large, 20% US large value, 10% US small, 10% US small value, 10% US REIT, 10% intl. large value, 5% intl. small, 5% intl. small value, 3% emg. mkts. large, 3% emg. mkts. value, 4% emg. mkts. small. The "60% Equity / 40% Cash & Bond" portfolio is represented by the DFA Normal Balanced Strategy, which is allocated to the following asset classes: 12% US large, 12% US large value, 6% US small, 6% US small value, 6% US REIT, 6% intl. large value, 3% intl. small, 3% intl. small value, 1.8% emg. mkts. large, 1.8% emg. mkts. value, 2.4% emg. mkts. small, 10% one-year US fixed income, 10% two-year global fixed income, 10% five-year US govt. bonds, and 10% five-year global fixed income.

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