The Mistakes Of 2008 – Will They Be Repeated Again?

It’s still everyone’s guess as to whether there will be repeat of 2008, or if we will be weathering the current global economic storms unscathed.

The WSJ (subscription required) implied in “Refresher Class: The Lessons of 2008 Are Timely Again” that lessons were actually learned, yet their recommendations do not seem to reflect that fact:

Investors learned tough lessons as financial markets melted down in 2008.

Some sold in a panic when stocks were at their lows. Others were surprised when fund managers proved just as capable of losing the nest egg as they were.

Now is probably a good time, with markets swaying again amid uncertainty about global economic growth, to ask yourself how well you learned your lessons from 2008.

“Smart people make mistakes,” says Larry Swedroe, director of research at Buckingham Asset Management in St. Louis. “What separates them from fools is they don’t repeat them.”

With that in mind, consider some key investing takeaways from 2008 that are fitting now:

1. Diversification isn’t a cure-all, but it works

Every major U.S.- and international-stock index lost money in 2008, as did many bond benchmarks. Moreover, assets that were considered less risky than others didn’t necessarily lose less. For example, many investors in 2008 believed that high-quality, dividend-paying large-cap stocks would buffer the shocks they expected would wallop riskier midcap and small-cap shares.

They were misguided. That year, the large-cap Standard & Poor’s 500-stock index posted a bigger loss than the small-cap Russell 2000 index.

Disillusioned, some market sages questioned the conventional wisdom that diversifying an investment portfolio will protect you in a down market.

They have a point, but only in the extreme.

One lesson for investors is that when pessimism is greatest, many investments that ordinarily go their own way are likely to tumble together. A market in free-fall crushes anything in its path, just as positive momentum tends to lift all boats.

Over longer periods, in contrast, you’ll get steadier returns with a mix of assets that don’t soar and sag in lock-step.

True diversification requires spreading a portfolio widely—across stocks, bonds, gold and other precious metals, real estate, commodities and the like— even if this means giving up some gains in bull markets.

2. Safe havens are necessary

Going into 2008, U.S. and international stocks had been the top-performing assets for five years running, and portfolio insurance in the form of Treasury bonds hardly seemed worth the bother. Yet once stocks went into a precipitous slide, U.S. government debt played its traditional protective role; Treasury bonds were the best place to make money in 2008.

Treasury trashers were back this year with dire warnings of America’s default and demise. Credit-rating company Standard & Poor’s even stripped U.S. debt of its coveted triple-A rating, a once-unthinkable action.

Michael Cuggino, manager of the Permanent Portfolio Fund, explains to MarketWatch’s Jonathan Burton why the lessons of 2008 are relevant today, including the importance of diversification, safe havens and avoiding overconfidence.

Yet Treasurys have outperformed most other investments so far this year, even rallying since the S&P downgrade in early August. Maybe, as some have quipped, U.S. debt is the cleanest dirty shirt in the world’s hamper. But prospects for slow economic growth have investors fleeing to the relative safety of federal and municipal bonds, pushing yields down and prices up.

“For fixed-income assets, stick only with Treasurys, bonds of government agencies and the highest-rated municipal bonds,” Mr. Swedroe says. “Anything else, such as high-yield junk bonds, convertible bonds, emerging-market bonds and preferred stocks, can have the risks show up at the wrong time.”

3. Money managers can’t save you in bear markets

In any given year, a large percentage of mutual-fund managers fail to beat their stock portfolios’ benchmarks. But when times get tough, many investors believe the pros deftly move into cash and other defensive areas, sidestepping the market’s worst blows.

That belief was shattered in 2008, along with fund portfolios. Actively managed U.S.-stock mutual funds lost 39% that year on average—worse than the S&P 500 and the broader Russell 2000 and Russell 3000 indexes, according to investment researcher Morningstar Inc.

This year has brought investors more of the same. For example, the S&P 500 lost 1.8% through August, including reinvested dividends, while actively run U.S.-stock funds were down 3.9% on average.

4. Beware emotional extremes

With stocks, it’s never “different this time.” To think it is smacks of overconfidence, which leads investors to forget history—and repeat it. Performance chasing, unrealistic expectations, market timing and other wealth-destroying behavior all stem from overconfidence.

Confidence was high in late 2007. The credit crunch was considered a troublesome spot but not a cancer. Stock investors also took comfort thinking that a once-in-a-generation mega-bear market had already occurred, in 2000-02, and so should be in hibernation for decades.

So when a second generational flood swamped Wall Street and Main Street only a few years later, even market veterans were stunned. “I remember saying, ‘I don’t think this bear market is going to be that bad,’ ” says Sam Stovall, chief investment strategist at Standard & Poor’s Equity Research, about conditions in 2008.

This year, investors lack confidence in stocks—maybe too much so. With global recession in their sights, many are selling before asking questions. Says Mr. Stovall: “The market has reacted as quickly as it did because it wasn’t going to be fooled again.”

There you have it: A variety of suggestions that are simply old wine in new bottles. Apparently, nothing has been learned from the 2008 meltdown or you should have seen a sensible recommendation such as getting out of equities altogether and staying in cash on the sidelines for a while.

Since that apparently is not even consideration for the author of this article, I simply have to conclude that nothing has been learned and all is business as usual. So don’t be surprised when the next bear strikes with full force to hear these words from above again ‘I don’t think this bear market is going to be that bad.’

It reminds me of the famous saying that “those who do not learn from history are doomed to repeat it.”

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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