Panic of 2008 Survivors

Thursday, April 02, 2009

What to Learn?

The Panic of 2008 claimed many major names in banking and insurance. The financial arena lost several major names to bankruptcy or takeover, Bear Stearns, Lehman Brothers, Merrill Lynch. A quick study of the monthly charts of the most impacted surviving companies still shows a scary reality. The amazing pace of these giants' fall is breathtaking especially considering that these companies were long considered some of Wall Street's most stable blue chips. Decades of earnings per share growth and steady capital appreciation in shares were wiped out in months. These charts demonstrate the rapid pace stocks can deteriorate when panic sets in.

Many investors lost fortunes as the S&P dropped 38.9% in 2008 with financial stocks losing 56.7% as a sector. The real lesson seems to be that investors need to respect the amount of risk in stocks as an asset class. Many investors will never recover the losses they suffered in the last year and a half. Financial markets have endured cyclical upturns and downturns over and over throughout history. The aging investor must remember that the unthinkable can happen and cash or low-yield government bonds may be the only place to find safety. Many an investor would be quite happy now if they had had a preservation of capital strategy rather than a growth objective.

It has long been an academic principle that investors should shift from risky assets to less risky assets as they age. The problem is that many financial advisers and pundits tout a buy-and-hold, long-term strategy claiming that stocks always gain over long periods of time. This logic gives a false sense of security to many who simply cannot weather a 50% loss in their household wealth. The most stable blue chip stocks can endure devastating losses when executives take long-term risks for short-term gains and equity holders suffer the pain.
While academics have told us for years to hold cash and bonds, many lost their appreciation for the inherent risks in equity holdings. Over time, massive losses will occur again and again reminding us that stocks are, in fact, very risky, as 2008 made clear once again.

The Stumbling Giants:

Fannie Mae and Freddie Mac required government nationalization to stay afloat. The US government massively diluted the common equity in order to maintain a stable housing market with both stocks losing 99% of their value erasing decades of capital appreciation.

Citigroup and Bank of America required massive capital injections through the government's Troubled Asset Relief Program to survive the meltdown. Both stocks lost over 90% from high to low again erasing decades of wealth creation

American International Group, the world's largest insurer, was essentially nationalized as the US government diluted equity holders to take a major stake in the company. The capital injections enabled AIG to maintain sufficient collateral for its bulging portfolio of credit default swap contracts. AIG lost over 99% of its value from high to low in just months.

The above monthly logarithmic charts are provided by Free Stock


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