The Slovenia Times

What We Can Learn from the Financial Crisis



Recently published data is mixed and does not clearly provide an answer to the question of what kind of economic environment is ahead. Nonetheless it is worth noting that our assumptions have been realised to a certain extent as growth slowed down significantly, especially in the US, whilst Europe and particularly Germany is currently performing much better.

Retail investors are often confused how to behave in the environment we live in. Their investments and savings generally suffered during the last crisis and they are now watching and waiting to determine what they should do. It is imperative to always maintain a cool head. When saving for a long term financial goal there is no reason to panic in times of market turbulence, of course assuming the portfolio of investments is well structured and diversified. Trending markets are an investor's friend as development is more predictable and investors can easily find justification for their actions that usually calms them. However, it is difficult to stick to a plan when market movements negate our belief and constantly challenge us.

Lessons from the past

The chart below may help investors understand how markets behaved historically when emerging from a financial crisis. At KD we derived a so called 'Financial Crisis Composite Index' and compared its movement to the current crisis which commenced in 2008. The index is composed of the: 1987 Savings and Loan crisis in the US; 1994 Financial crisis in Mexico; 1997 Asian debt crisis and the 1998 Russian financial crisis.

We deliberately looked only at financial crisis' as it is a well observed fact that an economic and financial recovery following a financial crisis is much more agonizing and longer in duration than recovery following a "regular" recession caused by non-financial factors. We determined the local stock market peak before each crisis began and combined it into a composite index we dubbed the Financial Crisis Composite Index. In the chart we rebased the crisis index to 2007 which marks the peak before the most recent financial crisis began and compared it to actual stock market movements in Developed (MSCI World Index), Emerging (MSCI Emerging Markets Index) and Regional* (STOXX Balkan ex Turkey & Greece Index) markets thereafter. The upper and lower bands represent plus and minus one standard deviation from the composite index and show variability.

*Regional markets: Slovenia, Croatia, Romania, Serbia, Bulgaria and Macedonia

Opportunity for long-term investors

As can be seen, the composite index forecast the stabilization and initial rebound in developed (black line) and emerging markets (blue line). The chart also shows that an initial rebound is followed by a phase of consolidation that lasts around 18 months and is then followed by a strong bull market lasting approximately 5 years. Currently developed and particularly emerging markets, trade on the upper band and a consolidation would not be a surprise. Regional markets have not rebounded as strongly as developed or emerging markets which can be explained by the relatively higher risk attributable to these markets. Risk aversion amongst market participants is still relatively high and regional markets are not yet in the investor spotlight. It can be expected that as economic recovery worries subside and risk appetite returns regional markets will outperform other markets.

We do not claim that the past will repeat but the chart serves as an interesting insight. Most noticeable is that periodical and continuous saving is very appropriate in the consolidation period as investors build up positions at attractive levels and then participate in the recovery that will fuel a new cycle of long term growth in stock markets. It can therefore be advisable, or prudent, for investors to invest regularly to achieve realistically set financial goals. A saving plan through which continuous contributions reduce the market timing risk and allow for building exposure gradually so the investor benefits from cost averaging. This approach is appropriate throughout the market cycle and particularly in the initial phase of recovery.

The views expressed in this article are those of the author and not necessarily those of the Slovenia Times

This report is provided for information purposes only and does not constitute financial or investment advice or form part of an offer, subscription, recommendation or solicitation to buy or sell any financial instrument, nor should it be relied on in connection with any contract or commitment. Returns are not guaranteed and past performance should not be relied upon for future performance as investment returns tend to fluctuate.


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