Instability is Stabilizing

Jim Steffen |

This month marks the ten-year anniversary of the climax of the 2008 financial crisis. That September, falling asset prices led to the bankruptcy of the investment bank Lehman Brothers. The collapse started a domino effect which nearly brought down the entire global financial system. Both the US economy and stock market bottomed out in the following months at different points in 2009.

A decade later, the US economy is humming along. Stock prices have jumped by over 300% from the bottom and are roughly double where they stood at the last market peak in 2007. In-fact, as I wrote last month, our current bull market for stocks is now the longest in history, surpassing the previous record set from 1990-2000. Perhaps more amazing is that this economic expansion is only months away from also setting a record.

With this ten-year anniversary, the Wall Street Journal has had a lot of content about the financial crisis in recent weeks. One column that really caught my attention is Greg Ip’s discussion of the psychological impact of past financial crises and how they change behavior.

Ip quotes the late economist Hyman Minsky who observed that, “stability is destabilizing.” Minsky’s observation was that periods of calm create a sense of safety and complacency in markets. This leads to increased risk taking which, left unchecked, can result in excesses such as asset bubbles.

But as Greg Ip pointed out in his column, the opposite is also true. Instability is stabilizing. For support, Ip highlights some of the trends and developments that followed the Great Depression of the 1930s:

“Americans decided to hold lots of cash. The federal government became the guarantor of economic security: banks got federal deposit insurance, the Federal Reserve devoted itself to preventing recessions, and the safety net was born with Social Security.”

Reading this struck a chord with me. The financial crisis of 2008 and ensuing recession were the most severe since the 1930s. The fall-out wasn’t as extreme (largely because of what is mentioned in the previous quote), but like The Great Depression, it caused behavior change.

In the months and years following 2008, consumers reduced debt, increased their savings rates, held more cash and made less risky investments. Likewise, businesses dramatically reduced debt and strengthened their balance sheets. Companies found ways to cut expenses and run leaner. They also took on far fewer risky projects and were much more restrained in their capital spending.

Risk aversion following a crisis may seem like a simple idea, but it provides profound insight to help explain why the current bull market and economic expansion have lasted far beyond anyone’s expectations.

One of my observations since 2008 is that everyone seems to be preparing for the next financial meltdown. Yet, here we find ourselves with both the longest bull market in history and an economic expansion poised to enter record territory of its own in the coming months. In hindsight, it’s clear that the mere expectation of another economic collapse has been a major contributor in preventing one from occurring.

One of the regretful consequences of this altered mind-set is countless investors have missed out on big gains as asset prices rebounded in recent years. Many people dialed back their exposure to stocks and real estate following the downturn. Sadly, those are the very assets that have appreciated most ever since.

For those providing investment advice, I always thought one of the big lessons of 2008 was you must educate your clients so they’re mentally prepared for market downturns. Looking back, my observation was that most of the investors that panicked during the sell-off probably knew little to nothing about investing or market history and therefore were completely unprepared for what occurred. The logical remedy for this seemed to be informing clients of the large market swings of the past so people would understand they may occur in the future.

In retrospect, I worry that talking about extreme market events has done less to position people to make better decisions and more to scare them into being overly conservative.

As I pointed out last month, it’s true that US stocks have declined by roughly 50% twice since the year 2000. Unfortunately, this narrowly spaced market tumult may be an aberration of history. If you look at market data going back to 1929, there has been only one other instance on par with the severe bear markets of 2000 and 2008 (the early 1970s).

Furthermore, despite some big swings over the past twenty years, those that did nothing except hold on have done fine. Just look at the Dow Jones Industrial Average over recent decades:

September 2018 26,000
January 2010 10,583
January 2000 11,497
January 1990 2,810
January 1980 824

As we mark the ten-year anniversary since the 2008 financial crisis, it’s important to recognize that these situations are extremely rare. Economists broadly agree that the events of that year were unmatched since the Great Depression, roughly 80 years before.

Additionally, understand the premise that “instability is stabilizing.” When people hear that the current bull market is the longest in history and the economic expansion isn’t far behind, many worry that this means the next collapse is around the corner. But in a strange twist, the fact that a lot of people are worried about it may in itself prevent one from occurring.

The time to be concerned isn’t when pessimism and caution are in the air…it’s when people start believing the good times will never end. Of-course, nothing is ever certain in markets. Risk taking is definitely on the rise and the current bull could end tomorrow, but I wouldn’t be surprised if the record run continues for some time.



Trott Brook Financial, LLC (“Trott Brook”) is a registered investment advisor. Mr. Erhart is also a registered representative of LaSalle Street Securities, LLC, a FINRA/SIPC member broker/dealer. Trott Brook Brook and LaSalle Street Securities are unaffiliated separate legal entities. Mr. Erhart may recommend that clients implement securities transactions through LaSalle instead of an advisory account under Trott Brook, depending on the needs of each client. This commentary is provided for informational and educational purposes only and should not be considered personalized investment advice nor a recommendation to take any specific action. Information contained herein is from sources that are believed to be reliable, but not audited by Trott Brook. Information is also at a point in time and may be subject to change without notice.