This fall marks 10 years since Lehman Brothers, the fourth-largest U.S. investment bank at the time, filed for bankruptcy protection. The wave of U.S. subprime mortgage failures that hit the housing and financial sectors spilled over into the broader economy and far beyond the U.S. The result was a global financial crisis (GFC).
A decade on, how has the damage inflicted by the GFC continued to shape both the global economy and investor behaviour?
"Obviously, we're in a much better place than we were a decade ago," said Roger Aliaga-Díaz, Vanguard’s chief economist for the Americas. "The global economy has been expanding, most developed economies are at or near full employment. And inflation remains modest despite unprecedented monetary stimulus.”
On the other hand, he says, "The GFC set in motion or accelerated some deep shifts in the global economy that leave us still short of pre-crisis normal. Aliaga-Díaz points to three key metrics. First, low interest rates. Before the GFC, global demand for so-called "safe assets," like high-quality government bonds, was already rising. The GFC triggered a worldwide collapse in the availability of those risk-free assets. The prices of remaining safe assets (like U.S. treasuries, British gilts and German bunds) hit extreme highs.
Bond prices and yields move in opposite directions, so bond yields and interest rates have reached historical lows. Will the global pool of safe assets remain small? It’s likely to, suggests Vanguard, which means long-term interest rates could stay at current levels for a while.
A second significant metric is the pace of global growth and trade. The financial meltdown slowed the debt-fueled consumption boom in the developed world. That, in turn, reduced the main growth driver for export-oriented emerging markets.
The drop in international trade has led some emerging markets, like China, to rebalance their economies, turning from export-oriented manufacturing production to domestic-oriented services. We’ve seen other emerging markets, especially commodity exporters, have a tough time re-orienting their economies.
In China, the annual growth rate averaged of about 10 per cent for the two decades before the GFC. In the last 10 years, it has been about 6.5 per cent. Overall, emerging-market growth has fallen from about 7 per cent to 4 per cent over the same period.
Aliaga-Díaz says a third metric to watch is wages. Typically, companies have to raise wages post-recession in order to attract and retain staff. However, with slowing global growth the demand for more workers isn’t as strong.
Demographics play a part too. The fall in the unemployment rate can be partly explained by retiring Baby Boomers, who’ve been replaced by younger (and cheaper) workers. After adjusting for inflation, wages have stagnated during this economic recovery.
With all of that, the financial markets have been relatively strong, with some caveats. What lessons should investors have learned from the GFC?
- Stay the course. In Canada, cumulative returns since September 2008 have been 56 per cent for stocks and 51 per cent for bonds. Even including the GFC, returns since 2008 have been healthy.
- Take a hard look at risk/reward. The markets rewarded investors who didn’t panic and remained disciplined. Yet there’s a greater fear of loss among some investors. Millennials who started investing with Vanguard after the GFC were twice as likely to hold zero-stock portfolios as those who started investing before the GFC. These investors seem to be swayed more by market risk than potential return.
- Reduce expectations. We may be heading into a period of lower portfolio returns over the next 10 years, says Greg Davis, Vanguard’s chief investment officer. He says a global balanced portfolio may return 3-5 per cent after accounting for inflation, compared with a historical return of around 7 per cent.
The global economy looks very different 10 years after the GFC. Yet. Davis says one thing that hasn’t changed is Vanguard's investment approach.
“Think about how much risk you can take on and still sleep, diversify your portfolio across the globe among stocks and bonds, and make sure to rebalance from time to time,” he says. “Those steps should still offer you the best chance for investment success.”
This content was produced by Vanguard. The Globe and Mail was not involved in its creation.