Bond funds are popular among risk-averse investors for a variety of reasons. U.S. Treasury bond funds are at the top of the list because they are considered to be one of the safest investments. Investors are not exposed to credit risk since the government’s capacity to tax and print money reduces the risk of default and protects the principal.
What assets rise in value during a recession?
- A recession is defined as two consecutive quarters of negative economic growth, however there are investment strategies that can help safeguard and benefit during downturns.
- Investors prefer to liquidate riskier holdings and migrate into safer securities, such as government debt, during recessions.
- Because high-quality companies with long histories tend to weather recessions better, equity investment entails owning them.
- Fixed income products, consumer staples, and low-risk assets are all key diversifiers.
During the Great Recession, which assets performed well?
With markets in shambles as the Coronavirus spreads, it’s worth looking back at the Global Financial Crisis of 2007-2009. This was the worst financial catastrophe most investors had ever seen.
- How could investors have secured their portfolios during the Great Recession and earlier financial crises?
What causes major bear markets and recessions?
The majority of financial crises occur when financial assets trade at inflated, often illogical, values. This can happen for a variety of reasons. Market bubbles are frequently fueled by “easy money.” Consumer price inflation is not as high as it used to be because of low interest rates and cheap borrowing. However, they do cause asset price inflation. Low interest rates and credit availability, along with market narratives, frequently result in bubbles.
Bubbles have popped in internet stocks, real estate (during the Great Recession), cryptocurrencies, and cannabis stocks over the last two decades. All of these bubbles had one thing in common: they all told a story about how big these businesses will become in the future. It doesn’t take much to start a trend with cheap money and a compelling story. The tendency is then interpreted as evidence that the narrative is right, resulting in an influx of buyers to the market. Bubbles are frequently fueled by regular investors, who are aided by the financial media.
In a nutshell, historical tendencies are extrapolated, and investors are concerned about missing out. Valuations and economic reality aren’t given any thought. One of two things happens eventually. There will be no more buyers when everyone who is likely to invest has already done so. Any negative news now will cause the trend to reverse.
On the other hand, news will eventually reveal how overvalued assets have gotten. The cannabis industry is a recent example. After recreational cannabis was legalized in Canada for a year, it became clear that the market was a fraction of what had been predicted.
What happened during the Global Financial Crisis?
Here’s a quick rundown of what happened leading up to, during, and after the Global Financial Crisis:
Between 2001 and 2006, the US housing market experienced a bubble. Low interest rates and a surge in subprime lending contributed to this. Lending methods became riskier as the bubble grew. Banks began to issue mortgage-backed securities, allowing institutions to participate in the subprime mortgage market. This insured that money could keep flowing into the market. The bubble would have broken much sooner if this hadn’t happened.
In their own trading operations, banks also increased the leverage they utilized. To meet demand, they began to develop fake goods tied to the mortgage market. Because of the scale of the bubble that was forming, several hedge funds and bank dealers were glad to offer these goods.
In 2006, property prices finally began to decline. This resulted in mortgage defaults by homeowners who relied on capital appreciation to fund their loans. Lenders foreclosed on homes and then attempted to resell them. The property market was put under even more strain as a result of this. As the number of defaults mounted, investors realized how much danger they had taken on by purchasing mortgage-backed securities. They attempted to sell the securities, but there were no takers at the time.
Mortgage-related funds began to fail in 2007. Notably, two Bear Stearns-backed funds failed, resulting in significant losses for the bank. Liquidity in the economy dried up as banks began to deleverage and restrict their exposure to the subprime market. The fallout from the banking and real estate industries expanded to the stock market in October, causing stock prices to plummet.
Early in 2008, the first economic stimulus package was passed, although it was too late for several businesses. Despite a bailout attempt by the US Treasury Secretary in March, Bear Stearns failed. To keep the entire mortgage market from collapsing, the government was compelled to take over Fannie Mae and Freddie Mac later in the year. Then Lehman Brothers went bankrupt, and Bank of America purchased Merrill Lynch, which was on the verge of going bankrupt.
Liquidity difficulties in US markets had begun to affect markets around the world by this time. The global financial system was drained of liquidity and credit availability due to a lack of liquidity in the US banking sector. This is why the credit crisis is commonly referred to as the market meltdown.
Around the world, economic stimulus programs were enacted between September 2008 and February 2009. The American Recovery and Reinvestment Act of 2009, the most recent of these, was a $787 billion economic stimulus plan adopted in February. Soon after, markets began to rebound but it took four years for stocks to recoup their losses.
What caused the GFC?
The Global Financial Crisis was brought about by a confluence of events. The reasons of the Great Recession can be divided into three categories:
Housing bubble
The Global Financial Crisis can be traced back to an increase of sub-prime lending combined with extremely low interest rates. Sub-prime loans are those granted to people who have poor credit, few assets, and may not have a stable income. Following the dotcom bubble, US interest rates peaked at roughly 7%. After that, by 2004, they had dropped to record low levels. Mortgages become more accessible for low-income people due to the low interest rate environment.
The mortgage industry has become extremely profitable and competitive. To ensure that they could obtain as much business as possible, lenders began cutting corners and even committing fraud. As a result, many people with little income and resources were forced to take out mortgages they couldn’t pay and didn’t comprehend.
The position in which government-backed mortgage markets found themselves magnified the volume and quality of mortgages. Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) are mortgage securitization businesses. The government backs the mortgages these businesses sell, but they still have to compete in the market like any other institution. They have to take on more hazardous mortgages sold by banks in order to maintain market dominance.
Despite the fact that interest rates began to rise in 2004, they remained historically low. More purchasers entered the real estate market as a result of low rates and easier access to financing. As a result, property values have risen. People began purchasing homes solely on the premise that the mortgage costs would be covered by capital gain. If you’re able to refinance or “You can effectively cover the mortgage with the capital gain if you “flip” a house at a higher price every few months.
As the subprime market got more competitive, lenders began issuing different types of mortgages in order to appeal to a broader range of potential house purchasers. All of these mortgages had one thing in common: they made mortgage payments more affordable for the first few months. The hitch was that in many situations, after an initial period, the repayments would climb. Lenders were unconcerned about defaults since defaulting would result in the lender becoming the owner of the property and house prices were soaring. Millions of people effectively become speculators with highly leveraged investments as a result of these loans.
People began purchasing second and third homes as a result of this strategy’s success. Many of them were bought with no-money-down mortgages. Furthermore, many of the mortgages were foreclosed on “For the first several months, the loans were “interest only” and required no repayments.
Complex financial products and leverage
The size of the Global Financial Crisis is largely due to the new financial instruments that contributed to the creation of the bubble. Bubbles usually burst when interest rates rise and there isn’t enough money to support greater prices. During the Global Financial Crisis, however, banks discovered a means to keep money pouring into the housing market, including the subprime sector.
MBSs (mortgage-backed securities) are mortgage pools that can be sold on secondary markets. MBSs have been replaced by collateralized debt obligations (CDOs), which are more complicated variants of MBSs. CDOs are divided into tranches based on their risk level. The safest tranches pay lower interest rates, whereas the riskier tranches pay higher interest rates. Rates AAA were the safest tranches, while rates BB- were the riskiest.
CDOs were repackaged throughout time to create new CDOs. The process of rating products became more obfuscated as the products became more complicated. CDOs containing exclusively high-risk mortgages were eventually rated AAA. This allowed pension funds all across the world to invest in the riskiest home loans, many of which they had no idea about.
New products were introduced as if dangerous derivatives with AAA ratings weren’t enough. Credit default swaps were introduced by banks to allow investors to insure their CDOs against default. These swaps have the same mortgage markets as CDOs. As a result, when the mortgage market started to slow, investors began betting on it via swaps. Credit default swaps were subsequently packaged into synthetic CDOs, which were new products. Rather than investing in mortgages, investors were betting on the mortgage market.
Fraud, conflicts of interest and regulatory failure
The Global Financial Crisis was facilitated by unethical behavior throughout the financial system. Fraud, conflicts of interest, and a lack of regulatory control were among the issues. To boost sales, mortgage originators frequently employed aggressive sales tactics and deception. Home buyers were urged to inflate their financial circumstances, and paperwork were frequently faked.
Rating organizations such as Standard & Poor’s and Moody’s were paid by the banks that constructed CDOs to rate the products. This created a significant conflict of interest because the rating agencies would only be compensated if the rating was favorable to the issuers. Banks were able to market exceedingly risky goods with investment grade ratings as a result of this. It also provided investors the misleading impression that the things they were purchasing were safe.
The issue was exacerbated by deregulation that occurred in the 1980s and 1990s. Bank trading operations expanded in importance and became a significant source of revenue. In addition, banks increased the amount of leverage they utilized to boost trading profits. Many banks and financial institutions realized they were too large to fail at the same moment. They understood that if things went bad, the government would bail them out.
When banks began wagering against their customers, another conflict of interest occurred. They produced items to meet client demand while also acknowledging that the products they were selling were extremely dangerous. They then began selling synthetic CDOs to clients, effectively wagering against them.
Regulators also contributed to the crisis by enabling risks to spread across the system. Although subprime lending was always understood to be dangerous, there was minimal regulation in place. The rating agencies were not regulated, allowing them to benefit from inaccurate ratings. And, with little action from regulators or central banks, banks were permitted to trade with growing amounts of leverage.
How did different asset classes perform during the Global Financial Crisis?
Because risk assets were hit so hard by the Great Recession, it’s important to understand how other asset classes fared. From the end of October 2007, when the S&P500 peaked, to the end of February 2009, when equities began to rebound, the following table shows how some of the key assets performed. The table also shows how long it took each asset class after February 2009 to recoup its October 2007 levels.
- All of the equity markets were highly connected. While emerging world stocks fared the worst, large-cap US stocks fared no better.
- The majority of alternative asset classes, such as hedge funds, gold, and commodities, outperformed traditional asset classes such as stocks and bonds.
- While some hedge funds did exceptionally well, those with negative reruns only lost about 5% of their value.
- Junk bonds, international stocks, and emerging market equities have yet to return to pre-crisis levels eleven years later. This is partly due to USD outperformance in the case of equities.
While each asset class’s performance differs from crisis to crisis, there is some continuity. The returns of 16 asset classes were examined in a Visual Capitalist article during the five major market crises, including the Great Recession. While the average losses were lower throughout all five periods, a similar pattern emerged.
Hedge funds, US treasuries, and gold were the best-performing assets. Stocks, junk bonds, and listed property investments were the lowest performers. Long-term returns must also be considered when looking at these returns. Long-term returns are higher for riskier asset groups. Long-term returns on alternative assets are lower, but they outperform during periods of market turbulence.
It’s also worth noting that individual hedge fund performance might vary significantly an index is a rough approximation of the returns of various sorts of funds. Some hedge funds that focused on subprime-related securities blew up during the GFC, while others returned more than 500 percent. Many of those who fared well in 2010 did not continue to do well after that. This emphasizes the point that hedge funds that specialize on a small number of markets may not be good long-term hedges.
How investors could have protected their portfolios during the GFC and other crises
The above returns demonstrate that, while risky assets such as stocks perform well over time, they can lose value quickly during a major event such as the Global Financial Crisis.
The only way to protect a portfolio from such disasters is to include alternative assets and bonds in the mix. The most reliable portfolio hedges are bonds, gold, and hedge funds. Because private equity, venture capital funds, and real estate are not marked to market every day, they can help to lessen volatility.
Conclusion: Learnings from the Global Financial Crisis
The Global Financial Crisis of 20072009 demonstrated the financial system’s complexity. The contagion swept across the world’s equity markets, causing even well-diversified equities portfolios to lose a significant amount of value. A portfolio with effective asset allocation can profit from long-term stock market growth while also surviving periodic downturn markets. Rebalancing asset classes also allows cash to be re-invested in risk assets when values are low and taken off the table when they are high.
Sometimes, like with black swan occurrences like the Coronavirus epidemic, there are warning indications before a catastrophe like the GFC, and sometimes there aren’t. The best way to avoid this is to diversify your portfolio at all times.
What do safe haven assets entail?
A safe haven investment is an asset that can be utilized to reduce an investor’s exposure to negative shocks by offsetting the risk in their portfolio. Safe haven assets generally beat the bulk of financial markets during a market collapse.
In a crisis, what is the most valuable asset?
Consumer staples have fared the best in both market crises. People must eat, wash their teeth, and purchase medicine regardless of the state of the economy.
Investing in the greatest consumer staples stocks will not protect you from stock market losses. However, if history is any indication, the sector should outperform the rest of the market.
Gold
If you’re looking for the greatest asset class to protect your portfolio against a financial catastrophe, gold is the way to go.
Gold saw favorable gains throughout the Dot-Com Crash and the 2008 Financial Crisis. When the S&P 500 fell by -22 percent in 2001, gold rose by a whopping 25%.
Since the turn of the century, it has been a safe and profitable area to invest money. With 12 years of positive returns, gold has weathered two financial crises and outperformed the S&P 500 in eight of those years.
Cash
This piece of advice may seem self-evident, but it’s more of a reminder. Because our common sense is frequently overtaken by avarice and promised returns.
This is especially true when it appears like people are making money in almost every asset classor, as my colleague Jared Dillian (a former Lehman Brothers trader) calls it, the “everything bubble.”
The S&P 500 hasn’t seen a correction in almost a year. Its market value increased by 29% in the first half of the year, with the five stocks accounting for 23% of that increase.
Before the market crashes, where should I deposit my money?
The best way to protect yourself from a market meltdown is to invest in a varied portfolio of stocks, bonds, and other asset classes. You may reduce the impact of assets falling in value by spreading your money across a number of asset classes, company sizes, and regions. This also increases your chances of holding assets that rise in value. When the stock market falls, other assets usually rise to compensate for the losses.
Bet on Basics: Consumer cyclicals and essentials
Consumer cyclicals occur when the economy begins to weaken and consumers continue to buy critical products and services. They still go to the doctor, pay their bills, and shop for groceries and toiletries at the supermarket. While some industries may suffer along with the rest of the market, their losses are usually less severe. Furthermore, many of these companies pay out high dividends, which can help offset a drop in stock prices.
Boost Your Wealth’s Stability: Cash and Equivalents
When the market corrects, cash reigns supreme. You won’t lose value as the market falls as long as inflation stays low and you’ll be able to take advantage of deals before they rebound. Just keep in mind that interest rates are near all-time lows, and inflation depreciates cash, so you don’t want to keep your money in cash for too long. To earn the best interest rates, consider investing in a money market fund or a high-yield savings account.
Go for Safety: Government Bonds
Investing in US Treasury notes yields high returns on low-risk investments. The federal government has never missed a payment, despite coming close in the past. As investors get concerned about other segments of the market, Treasuries give stability. Consider placing some of your money into Treasury Inflation-Protected Securities now that inflation is at generational highs and interest rates are approaching all-time lows. After a year, they provide significant returns and liquidity. Don’t forget about Series I Savings Bonds.
Go for Gold, or Other Precious Metals
Gold is seen as a store of value, and demand for the precious metal rises during times of uncertainty. Other precious metals have similar properties and may be more appealing. Physical precious metals can be purchased and held by investors, but storage and insurance costs may apply. Precious metal funds and ETFs, options, futures, and mining corporations are among the other investing choices.
Lock in Guaranteed Returns
The issuers of annuities and bank certificates of deposit (CDs) guarantee their returns. Fixed-rate, variable-rate, and equity-indexed annuities are only some of the options. CDs pay a fixed rate of interest for a set period of time, usually between 30 days and five years. When the CD expires, you have the option of taking the money out without penalty or reinvesting it at current rates. If you need to access your money, both annuities and CDs are liquid, although you will usually be charged a fee if you withdraw before the maturity date.
Invest in Real Estate
Even when the stock market is in freefall, real estate provides a tangible asset that can generate positive returns. Property owners might profit by flipping homes or purchasing properties to rent out. Consider real estate investment trusts, real estate funds, tax liens, or mortgage notes if you don’t want the obligation of owning a specific property.
Convert Traditional IRAs to Roth IRAs
In a market fall, the cost of converting traditional IRA funds to Roth IRA funds, which is a taxable event, is drastically lowered. In other words, if you’ve been putting off a conversion because of the upfront taxes you’ll have to pay, a market crash or bear market could make it much less expensive.
Roll the Dice: Profit off the Downturn
A put option allows investors to bet against a company’s or index’s future performance. It allows the owner of an option contract the ability to sell at a certain price at any time prior to a specified date. Put options are a terrific way to protect against market falls, but they do come with some risk, as do all investments.
Use the Tax Code Tactically
When making modifications to your portfolio to shield yourself from a market crash, it’s important to understand how those changes will affect your taxes. Selling an investment could result in a tax burden so big that it causes more issues than it solves. In a market crash, bear market, or even a downturn, tax-loss harvesting can be a prudent strategy.
What is the most secure investment?
Cash, Treasury bonds, money market funds, and gold are all examples of safe assets. Risk-free assets, such as sovereign debt instruments issued by governments of industrialized countries, are the safest assets.
Is gold still considered a safe haven investment?
When markets are down or inflation is increasing, gold is often considered as a safe haven. People are deferring jewelry purchases while gold prices remain around all-time highs. Along with a sluggish wedding season, orders with open and settled prices on delivery day are also being canceled.
Apart from high and erratic prices, the safe-haven asset has yet to see a gold rush, limiting demand. Because gold prices have risen so quickly, there has been little demand for positional investments at this time. Participants in the market hope for…
Since 1992, what asset hasn’t had a negative year?
The abundance of free research and investing tools is one of the reasons we’re living in the golden age of the individual investor.
All of the tools we utilized when I initially started working in the investment industry were subscription-based or pay-to-play. There are certainly some things worth paying for, but there is also a lot of free information available on the internet.
For years, I’ve relied on NYU professor Aswath Damodaran’s annual asset class returns. It’s updated once a year and includes annual returns for the following years since 1928:
From 1928 to 2019, I went through and estimated the annual return numbers for each:
He also incorporates annual inflation so that the returns can be compared on a real-world basis:
Inflation in the United States has been low for a long time, but it wasn’t always like this:
On the graph, you can detect two inflationary spikes. One occurred during WWII, while the other occurred in the late 1970s and early 1980s. By historical standards, inflation has remained reasonably stable since then.
Inflation in the United States reached over 63 percent from 1942 to 1948. It was over 60% from 1977 to 1981. Inflation has increased by 60% since 1998. That means it took 22 years to see the kind of inflation individuals had to contend with in the past over 7 and 5 year intervals.
Is it possible that inflation will remain low for a long time? Based on demographics and growth projections, there’s a strong case to be made for this.
But we can never be sure, and even if the long-term trend is reduced inflation, outlier occurrences that create short-term inflationary surges are impossible to forecast.
The vast range of outcomes that might occur in the three asset classes with the greatest, average, and minimum calendar year returns is also instructive:
Long-term returns are tough to predict precisely, but I could give you a range (say, 4% to 12%) for the stock market over a 30-40 year span and feel fairly confident about it. However, in the short term, the range of outcomes is wide enough to accommodate six Teslas.
The S&P 500’s yearly returns have averaged 9.7% during the last 92 years, while roughly 70% of all calendar years have seen returns of more than 10% or less than -10%. As a result, most of the time, stocks are either up or down.
Bonds, on the other hand, only had one year in which they sank by double digits (2009 when they fell 11 percent ). Bonds are being suffocated by inflation. Since 1928, 10-year treasuries have had only 17 down years out of 92, but on an inflation-adjusted basis, they have been down 40 years, or nearly 44% of the time.
Cash has never had a bad year, which is reassuring in the short run. However, when accounting for inflation, 3-month t-bills were down 38 out of 92 years. On a real basis, stocks have lost money in 30 of the last 92 years.
Let’s look at annual returns for various asset types over a variety of time periods simply for fun.
Because that period began with incredibly low valuations and ridiculously high interest rates, the markets have been amazing since 1980:
Stocks have performed admirably, but bond returns have been out of this world when compared to pre-1980s markets. Before 1980, the returns were decent, but nothing compared to what we’ve seen since then:
However, the influence of the Great Depression on long-term stock returns is astounding. Here’s what things look like if you start from 1933 and take the crash out of the equation:
Here are the returns during the last 20 years, which may have been the worst starting place in the history of the United States stock market:
Bonds have practically beaten stocks this century, notwithstanding the great gains of the last 11 years or so. Here are the highlights from the previous 11 years:
The S&P 500’s total returns from 2009 to 2019 (+345%) outperformed the total returns from 2000 to 2019 (+221%) by a large margin.
All of this is obviously cherry-picking. We can’t just ignore history’s worst crash or only consider equities from their best or worst entry opportunities. Looking at asset class returns across a variety of market circumstances, on the other hand, can help build better expectations for what’s to come.
Perhaps a better approach to think about this is to consider asset class yearly returns and inflation for each decade:
Again, arbitrary start and end dates, but in terms of equities, bonds, cash, and inflation, no two decades are alike.
What exactly is a three-asset solution?
- Asset allocation is an investment technique that tries to balance risk and reward by allocating assets in a portfolio based on a person’s goals, risk tolerance, and investment horizon.
- Because the three primary asset classesequities, fixed-income, and cash and equivalentshave different risk and return characteristics, they will react differently over time.
- There is no one-size-fits-all formula for determining the best asset allocation for each individual.
Where should you deposit your money to be safe?
Because all deposits made by consumers are guaranteed by the Federal Deposit Insurance Corporation (FDIC) for bank accounts and the National Credit Union Administration (NCUA) for credit union accounts, savings accounts are a safe place to keep your money. Deposit insurance pays out $250,000 to each depositor, institution, and account ownership group. As a result, most people do not have to worry about their deposits being lost if their bank or credit union goes bankrupt. If you’ve received some additional cash as a result of an inheritance, a work bonus, or a profit from the sale of your home, you may be investigating other safe options for storing your funds in addition to a savings account.