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Rekenthaler Report

Every Financial Crisis Is Different

And the best investment response is the same.

Looking Back
Stock-market declines are always obvious in hindsight. When technology stocks reversed course in spring 2000, after years of gains, the New Era was over. Prudent investors exited. Several years later, The Big Short informs us, the smart money understood that the housing market was dangerously overheated. Most shareholders failed to perceive the problem, being caught up in the excitement, but those who viewed the situation dispassionately realized that the game was up.

Perhaps the Brexit vote will prove the same. Perhaps 2025's Best Picture Oscar will go to a sweeping satire on the collective foolishness of the nation's wealthy, who reaped huge profits on their post-2008 portfolios only to give back those gains during the global depression caused by Europe's breakup. The truth was directly in front of them--but they were blind! The audience leaves satisfied; the rich got what was coming to them.

That could be. Or it could be that Brexit will affect U.S. stock prices much like Greece's financial crisis, Putin's aggressions, S&P's downgrade of U.S. debt, and Washington's budget brinkmanship. Those items splattered against the U.S. marketplace like a water balloon hitting an elephant. At the time, each seemed to be globally important, causing several weeks' worth of stock-market losses accompanied by anxious commentary.

A sample of the latter, from 2011:


But the move by S&P still could serve as a psychological haymaker for an American economic recovery that can't find much traction, and could do more damage to investors' increasing lack of faith in a political system that is struggling to reach consensus even on everyday policy matters. It could lead to the prompt debt downgrades of numerous companies and states, driving up their costs of borrowing. Policy makers are also anxious about any hidden icebergs the move could suddenly reveal.


At the time, that passage seemed to make a lot of sense. The economy was sputtering, growing much more slowly than one would hope coming out of a deep recession. Business and consumer confidence was low, politicians were wrangling, and U.S. credit had just been downgraded. It didn't take much imagination to envision the shakes becoming a collapse, with rising credit spreads leading to a flight to quality by investors, corporations getting spooked and cutting back on spending plans, and so forth.

The S&P 500 hiccupped, then gained 16%, 32%, and 14% over the next three years. Nobody will make a film mocking the folly of those overconfident 2011 investors.

My point? The market's turning points are never evident until after they have occurred. Sure, tech stocks were very expensive in 2000 and were discussed with a fervor that approached hysteria. (Morningstar's technology-stock analysts received several threats, including death, for being insufficiently bullish.) It didn't take the brightest of bulbs to realize that they were no bargain. But they hadn't been a bargain four years before, either, when Alan Greenspan bemoaned the market's apparent "irrational exuberance."

New Heroes
To which a reasonable response would be that the market's turning points may not be evident to a blogger, but they certainly are to the best and brightest. As The Big Short showed, investors of various backgrounds figured out the housing bubble before it popped. Many more anticipated the 2000-02 tech bust, as hundreds of hedge funds dodged that downturn altogether. There were plenty of managers who avoided the 1987 crash, too, including several who ran mutual funds.

Unfortunately, almost none of them repeat their successes. The heroes (and heroines) of 1987 flopped during the 1990s bull market, so that they were no longer running money when the next bear showed up. The hedge funds that fared so well at the start of the New Millennium got caught out when the next bear market arrived, in 2008. The stars of the financial crisis have not shone, either. Most notably, the biggest of the big shorts in 2007, John Paulson, was recently forced to invest some of those profits back into his ailing hedge funds.

Thus, the following can be said of the United Kingdom's Brexit vote:

  1. It might be the top of the current bull market, or it might not.
  2. If it is indeed the top of the bull market, some investment managers know that, and will profit handsomely.
  3. Unfortunately, we do not know who those managers are. They're not the people who avoided previous bear markets. They are instead newcomers. They will get this call right--but only this call. They will not anticipate the next bear market, nor likely any other bear market.


To call the bear-market stars lucky, in the sense that dart-throwing monkeys or a mouse-tossing cat could replicate their feat, is an oversimplification.

To be sure, some investment managers were fortunate. They sensed some aspect of the eventual truth, without achieving full understanding of the issues; they invested with their intuitions; and when the bear market arrived, they talked themselves and observers into believing that they knew it all along. Those managers did not know it all along. They hoped that they were correct, and the coin turned up heads.

But others fully deserved their success. They did the relevant analysis and realized that that a downturn was inevitable. The losses must arrive. (Of course, as vividly shown in The Big Short, the exact timing of the bear's arrival cannot be known, and much suffering can occur while awaiting that event. When it comes to profiting from bear markets, one can be right and yet wrong.)

History's Limits
The problem is that one potential bear market is not like another. Each market upheaval differs in its details, enough so that a manager who determines the correct analysis in one case cannot see the problem in the next. (Or, perhaps, that manager has the opposite difficulty, and forecasts eight of the next two bear markets.) The skill of a bear-market savant is not transferable.

Every financial crisis is different. Because of that, we cannot apply lessons from the past to learn about the future. Nor we can look to those who made the right call last time. There's nothing to do, logically, but to trudge along as always, on the logic that the markets go up more than they do down and that, without the benefit of hindsight, we cannot know which investment expert will be correct about this particular crisis.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.