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Who could blame an investor today for feeling a tad nostalgic for the Panic of 2008? There was a simplicity to the thing. It was such a brutal and impartial rout—slaying just about every asset class—that it made you want to swear off all markets forever. There was comfort to be found in stashing a shoebox full of $50 bills in the freezer. No paperwork. No jabberwocky from your broker. Just the reassuring face of Ulysses S. Grant juxtaposed with your cold, raw fear.
By March 2009, with U.S. stocks at 1996 levels, equities had returned less than Treasuries over the previous 10-, 20-, and 30-year periods—debunking the equity-risk premium so central to Econ 101. Until, of course, the market reversed course and surged 80 percent in 13 months, reminding investors that it was at least theoretically possible to make money in equities. That change of mood edged out fear just in time for the 2010 edition of the credit crisis, an international production that began with Greece's near-collapse and soon spread to Portugal, Ireland, Italy, Spain, and beyond. The Standard & Poor's 500-stock index has now fallen 12 percent in a month, its first official correction since the new bull began last spring.
Corrections are routine and even healthy events; they come along about once every 11 months on average and wring out the excesses and false expectations that rallies inevitably bring. "To the extent that current worries squeeze long positions, extinguish optimism, or even lead policymakers to pursue courses of action that are more supportive—not more punitive—for markets, the selloff may be creating more favorable entry points for investors to buy into a still recovering global economy," writes Stuart Schweitzer, global markets strategist for JPMorgan Private Bank, in a May 24 note to clients. That may all turn out to be true—provided investors don't panic, rush for the exits, and help turn a routine recovery into the second leg of a double-dip recession.
If the lesson of March 2009 is that the sun comes up—the most brutal selloff is just a prelude to the next rally—then the lesson of the recent runup is that the sun can shine too brightly, blinding us to boulders in the road. And then it can set.
With payrolls still slack and credit still tight, the contours of these peculiar economic times are becoming apparent. Last year's snapback is not going to bring a garden-variety, V-shaped recovery. Instead, investors are again having to confront the messy unfolding of a long and overly generous credit cycle, global in nature and marked by a spate of bank and business failures. How the economies of the world digest it is anyone's guess. When the next leg up begins, though, it will mark a critical milestone for a stock market that still needs to rally by almost half to revisit its 2007 high. Getting there despite profound economic challenges is going to take some hard traveling.
"In the U.S., we have no living precedent for this," says Donald Luskin, chief investment officer at strategy firm Trend Macrolytics, whose search for domestic parallels to this credit crisis took him all the way back to 1907. "We have had a living laboratory for it in Japan for the past 15 years. But in the U.S., we're all attuned to the little upticks in metrics that don't necessarily inform much." In other words, we seek auguries where there are none by comparing traditional business cycle statistics such as payrolls and housing starts to once-in-a-lifetime lows from late 2008 and early 2009. Luskin predicts the market will be range-bound for at least five more years as companies and consumers shed debt. "This is not a particularly bearish view," he says. "It's just the expansion-less, low-return world we're now in."
Luskin's unenthusiastic outlook—which contrasts with the prevailing optimism among Wall Street strategists in a May 25 Bloomberg survey—brings to mind the "new normal" paradigm coined last year by Bill Gross and Mohamed El-Erian at Pimco, the bond giant. The idea is that a bitter confluence of deleveraging and reduced consumption and employment will necessarily bring a long period of low growth and low returns. In the absence of a healthy consumer, the neo-normalists point out, there is no other driver to magically propel the economy.
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