Biggest Surprises in a Tumultuous Year

4Q 2008

In this very piece a year ago we assured you that 2008 would be an “adventure”. Given the events that unfolded, we doubt that anyone could now question the accuracy of that prediction. That said, being able to forecast adventurous times ahead is much different than knowing the future. In the following paragraphs, we’ve borrowed portions of a Top 10 list recently produced by Fidelity’s Market Analysis, Research & Education unit to highlight the most surprising developments in the financial markets during the tumultuous year gone by.

1) Historic Sell-Off, Almost Nowhere to Hide. Risk aversion was the market’s mantra, and anything that lacked the absolute backing of the U.S. government lost money. Domestic stocks posted their worst returns since the 1930’s (S&P 500 fell 37%). Foreign stocks fared even worse, with both developed and emerging markets recording their largest declines ever. The more shocking thing about 2008, however, was not that global equity markets all fell at the same time. It was that high quality, non-government fixed income failed to deliver the strong returns that diversified investors are accustomed to in equity bear markets. Never have valuations declined so quickly across such a wide variety of asset categories.

2) Gut-Wrenching Volatility. By a variety of measures, the financial markets achieved levels of volatility not seen since the Great Depression. Nearly 17% of all trading days ended in a move that was 3% or more. And while many of those days were negative, 2008 did include the biggest single day rally (up 11.6% on October 13th) and the biggest five day rally (up 19.1% from November 21st to November 28th) since 1933.

3) Financial Landscape Changed Forever. Within a span of months, several storied financial institutions either went bankrupt (Lehman Brothers and Washington Mutual), were merged away (Bear Stearns, Merrill Lynch, and Wachovia), or found themselves begging the government for a lifeline (AIG and Citigroup). Dozens of others have received capital injections as part of the $700 billion Troubled Asset Relief Program. Increased regulation will surely be the outcome.

4) From Inflationary Worries to Deflationary Threat. In July, as oil was near $150 per barrel and other commodities were also surging, the government’s Consumer Price Index (CPI) rose to 5.6%. This was the highest year-over-year reading in 17 years, and was reason for concern among policy makers. However, as the global economic crisis intensified, overall prices actually retreated in October, November, and December. The final CPI reading for 2008 came in at just 0.1%, the lowest in 54 years. Policy makers are now challenged with preventing an extended period of deflation.

5) Unprecedented Government Response. Fiscal and monetary policy makers both domestically and across the globe have moved swiftly to unveil what is potentially the largest and most broad-based economic stimulus effort in history. While these responses likely present massive challenges going forward (budget deficits, inflation, etc.), they may be the reason why the current outlook does not resemble the 1930’s.

Having now looked backward, we would like to make an early nominee for the biggest “surprise” of 2009, which is that the level of fear currently in the market will be overcome by rational and disciplined investor behavior. While many economic potholes surely lie ahead, forward-looking markets combined with more attractive valuations certainly breed hope.