2015, The New 2008

It has been 7 years since the financial crisis of 2008 gripped the world, although it still makes the news on a regular basis. Perhaps in order to avoid chaos, just before the crash many leaders were quoted as saying everything was fine and knowing that it wasn’t.

“The subprime mess is grave but largely contained”

Federal Reserve Chairman, Ben Bernanke, in a speech before the Federal Reserve Bank of Chicago. During another interview, he was quoted as saying,

“Well, I guess I don’t buy your premise. It’s a pretty unlikely possibility. We’ve never had a decline in house prices on a nationwide basis. So what I think is more likely is that house prices will slow, maybe stabilize: might slow consumption spending a bit. I don’t think it’s going to drive the economy too far from its full employment path, though.”

If that weren’t distressing enough, the following predictions are from other leaders across the financial services:

“A very powerful and durable rally is in the works. But it may need another couple of days to lift off. Hold the fort and keep the faith!”

Richard Band, editor, Profitable Investing Letter, Mar. 27, 2008. At the time of the prediction, the Dow Jones industrial average was at 12,300.By late December it was at 8,500.

“I think you’ll see [oil prices at] $150 a barre  Best Lawyers Near Me l by the end of the year”

T. Boone Pickens, June 20, 2008. Oil was then around $135 a barrel. By late December it was below $40.

Finance and housing forecasters missed the mark as well:

“[AIG] could have huge gains in the second quarter.”

Bijan Moazami, analyst, Friedman, Billings,Ramsey, May 9, 2008. AIG wound up losing $5 billion in that quarter and $25 billion in the next. It was taken over in September by the U.S. government, which will spend or lend $150 billion to keep it afloat.

“I think this is a case where Freddie Mac (FRE) and Fannie Mae (FNM) are fundamentally sound. They’re not in danger of going under…I think they are in good shape going forward.”

Barney Frank (D-Mass.), House Financial Services Committee chairman, July 14, 2008. Two months later, the government forced the mortgage giants into conservatorships and pledged to invest up to $100 billion in each.

“I think Bob Steel’s the one guy I trust to turn this bank around, which is why I’ve told you on weakness to buy Wachovia.”

Jim Cramer, CNBC commentator, Mar. 11, 2008. Two weeks later, Wachovia came within hours of failure as depositors fled. Steel eventually agreed to a takeover by Wells Fargo. Wachovia shares lost half their value between Sept. 15 and Dec. 29.

“Existing-Home Sales to Trend Up in 2008”

Headline of a National Association of Realtors press release, Dec. 9, 2007. On Dec. 23, 2008, the group said November sales were running at an annual rate of 4.5 million-down 11% from a year earlier; the worst housing slump since the Depression.

Not everyone was caught off guard by the crash of 2008. Here’s a Fortune list of some who predicted it.

Unfortunately, many who saw the crisis looming on the horizon didn’t get headline attention; probably because they weren’t employed by high profile institutions. In finance, a market crash is considered a systemic risk, or risk beyond investors’ control. Although they cannot be prevented, they do provide warning signs. Concerns now lie in the fact that once again, markets are at all-time high with exuberance among investors and many ignoring the possibility of a crash.

Here, I’ll coin the term “Crisis Advisor” to refer to a financial advisor who doesn’t ignore the possibility of a crash and builds contingencies into an investment strategy. A crisis advisor would also keep a close pulse on the markets and be prepared to warn his clients if he sees risk mounting. Some clients may choose to stay in the market, others may not. The point is, the advisor has done his fiduciary duty in protecting his client’s assets.

Too many believe in the advice, “just stay in the market and even if it goes down, you’ll still make money.” This ignores the fact that time is as valuable as money, so having a portfolio lose half its value is only part of the problem. The other is the time lost waiting for it to regain its worth. What if the investor is64 and doesn’t have 5 years to wait? Equally grave is the cost of years of lost growth. For instance, 6% of 500,000 is obviously more than 6% of 250,000.

Many “Don’t want to miss the bull market.” However, there’s a wide gulf between missing a bull market and getting out before a crash; years in fact. Investors may miss the last 10-20% run up, but they’ll also miss the 50-60% run down. That’s a gain of 30-50%.

The Catalyst

Every downturn starts with a catalyst, something which cracks the public psyche and acts as a sign of things to come. Often the catalyst seems contained at first, or is written off due to it having no effect on individual investors. Such is the case with the recent crash in the price of oil, where at $54 a barrel, it’s roughly half where it was at its’ peak in 2014.

The oil sands currently provide jobs for 514,000 people across Canada (direct, indirect and induced). Every dollar invested in the oil sands creates about $8.00 worth of economic activity, one-third of which occurs outside Alberta’s borders – in Canada, the U.S. and around the world.

An industry like oil is an economic driver, meaning that it creates more economic benefits than just the dollars it brings. Service industries benefit, everything from specialized drilling companies to machine shops, lawyers, engineering firms, and consultants. So to suggest that it will have no affect on jobs and investment outside the energy industry is not only mistaken, it has been disproven time and again by each oil bust in history.

Currently, the federal government is saying it will only suffer $2-3 billion in lost tax revenue. This is assuming there will be no tax revenue losses outside the energy industry. When big oil starts cutting spending, the affects will cost the federal government far more than the direct loss of taxes from lost oil profits.

The following is a list of Canada’s most important economic drivers, the industries which drive the economy and make all other industries more profitable and viable.

1. Mineral fuels including oil: $119,735,428,000 (26.1% of total exports)

2. Vehicles excluding trains and streetcars: $59,311,332,000 (13%)

3. Machinery: $31,159,852,000 (6.8%)

4. Pearls, gems, precious metals and coins: $23,163,095,000 (5.1%)

5. Electronic equipment: $14,119,823,000 (3.1%)

6. Plastics and plastic articles: $12,586,302,000 (2.7%)

7. Aircraft, spacecraft and equipment: $10,466,591,000 (2.3%)

8. Paper: $8,597,848,000 (1.9%)

9. Aluminum: $8,529,558,000 (1.9%)

10. Ores, slag and ash: $8,460,935,000 (1.8%)

Here’s the USA’s top export list

1. Machinery: $213,108,199,000 (13.5% of total exports)

2. Electronic equipment: $165,604,449,000 (10.5%)

3. Mineral fuels including oil: $148,426,743,000 (9.4%)

4. Vehicles excluding trains and streetcars: $133,640,479,000 (8.5%)

5. Aircraft and spacecraft: $115,380,944,000 (7.3%)

6. Optical, technical and medical apparatus: $84,281,276,000 (5.3%)

7. Pearls, precious stones, precious metals and coins: $72,830,232,000 (4.6%)

8. Plastics: $60,836,970,000 (3.9%)

9. Organic chemicals: $46,510,903,000 (2.9%)

10. Pharmaceutical products: $39,742,717,000 (2.5%)

In Canada, the top of the list is mineral fuels, of which oil is by far the largest contributor and almost exactly twice the size of the next largest, auto manufacturing. In the USA, mineral fuels makes it to number 3, still a critically important industry to the country. It’s important to note that some of these industries are already in full scale downturn, including ores and ash, precious metals, aluminum, and paper, which never recovered fully from 2008.

It’s also concerning that record breaking recent auto sales recently were achieved with equally record breaking low interest rates. In Economics terms, that is “pulling demand forward”, supposedly a temporary measure to give a little lift to an economy, not a 6 year embedded monetary policy. The problem with leaving rates this low for this long, is that a full cycle of mortgage renewals, car loans, and big ticket items are sold at unsustainable interest levels. Did you know we currently have the lowest rates in recorded history, for the longest time in history? This means governments are terrified and know they need to do whatever they can, otherwise the economy will crash.

Adapt, Don’t React

Had the crash of 2008 been anticipated, allowing for preparation, losses might not have been as great. In 2007-2008, investors were being misled with a false sense of security. This is occurring less frequently today. The Bank of Canada has advised that real estate is 10-30% overvalued and the International Monetary Fund has warned Canada to get its fiscal house in order because Canadian debt is increasing to new record levels.

Many financial advisors didn’t anticipate the last crash. They were advising their clients to “buy and hold” as the best strategy. Many bought and held, and saw their net worth drop significantly. Some say it doesn’t matter because the market came back. However, one must recognize the value of time when it comes to money.

Advisors must understand that bull markets don’t last forever, and therefore watch for the warning signs and clients out of danger early, before the crash. There are two strategies to investing: one can miss the last gains in a bull market and also miss the crash, or choose to go for every last gain, but also suffer the crash. The final gains are nowhere near as large as the final losses. Take the early option.

Fiduciary duty is the concept of protecting your client the way you would protect yourself. It’s a very serious commitment I believe many in the financial services industry have overlooked by presuming that clients should be responsible for their investment choices. This is not a fulfillment of duty. Clients pay advisors to watch every market move and protect their assets. Advisors are people, and therefore subject to denial, which can be very costly. There’s never been a bull market that didn’t crash. In spite of this fact, terms like “soft landing” are discussed, as if any market has ever had one.

Making Money in a Rising Market

After 6 years of solid gains, this is now the 2nd oldest bull market in history. Bull markets don’t last forever, and the true test of a financial advisor is not how they handle rising markets, but how they handle falling markets. A skilled advisor can make money in any market. Equally important, they prevent losses when markets fall. I’m calling for financial advisors across the industry to shoulder responsibility for losses as well as gains.

For example, energy companies across the board are down double digits, and energy makes up a very large proportion of many mutual funds and investor portfolios in Canada. How many financial advisors saw this happening and warned their clients? Even warning after one month would’ve saved clients roughly 25%.

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