As major indices have fallen 30% off the highs, with the potential for further declines, so what are the similarities and differences to 2008?
The most unique aspect to this market crisis is the sheer speed of the decline. The S&P 500 has dropped 30% in a month, in the crisis of 2008 a 30% drop from the market’s high took almost a year. If 2008’s decline was a Toyota Camry, this decline is a Ferrari.
Government reaction too, has been swift. The Fed has already cut the effective fed funds rate to zero, with additional liquidity measures. Government stimulus also appears to be coming very soon. Events are moving on a more rapid timetable than 2008.
Valuation is an important consideration too. Here, it is perhaps best to look at Shiller’s price earnings ratio. This smooths 10 years of earnings to arrive at an averaged, longer-term earnings number against which to value the markets. That’s helpful because we have no idea what 2020 earnings will look like at this point and CEO’s may chose to kitchen sink the numbers this year by recognizing any loss they can reasonably find. As such, earnings could be substantially lower than 2019, causing the market’s 2020 price to earnings ratio to rise materially on a lower denominator. Again, we saw something similar in 2008.
Schiller’s price earnings controls for this issue. Current estimates put the Shiller price earnings ratio at 22x. Over the 2008 period it declined from 25x to 15x. If that played out again, the S&P 500 would bottom at around 1,600 compared to approximately 2,300 at the time of writing.
One key difference to the latter stages of 2008, though, is we don’t have much economic data in yet whereas in the last recession the data evolved more gradually and the picture was clearer. The Fed’s James Bullard is estimating 30% unemployment in Q2 2020. Despite the Fed’s technical skill, that’s obviously conjecture at this point.
One critical difference to 2008 is, of course, that this is an intentional decline. Businesses are shutting down, not for lack of typical demand, but to purposely control the virus.
In 2008, business practices that were quite unsustainable came to a halt. There’s an important distinction. Many activities in the froth of the housing bubble were downright reckless. In contrast, many activities having to shut down today from airlines to sit-down restaurants are necessary for the economy. The question of course, is whether, and how fast, all these activities can return once normality resumes. The issue in 2008 was making sure some of the more extreme activities like providing multiple mortgages to individuals without material income never returned. Today the question is how quickly we can bring things back.
Also, note a comparison with 2008 is necessarily a pessimistic setup for investors. 2008 itself had echos of the 1930s. So a comparison with 2008 is a comparison with one of the absolutely worst market environments on record. That may not come to pass.
Also, though there’s a tendency to focus on how bad it could get and where the ultimate market low may fall. However, following the same pattern, buying at the same decline point in 2008 an investor would also be back to even within around a year, and doubled their money 6 years later.
Thus 2008 tells us that things can get worse, but it also tells us that environments of real panic can often create real opportunity for disciplined longer-term investors.