The old stock market adage that you should sell at the top and buy at the bottom might need to be revised. The US stock market hit a peak 10 years ago on October 9 2007, before starting to collapse during the financial crisis. And yet anyone who bought the S&P 500 then would by now have doubled their money.
As the chart shows, the US stock market has returned far more than stocks in the rest of the world, or bonds, or even gold. Prices of the precious metal surged during the crisis, as investors positioned for disaster, and inflation. But over the past five years, as inflation failed to materialise, gold has subsided.
How did this happen? The primary driver for much of the time was the Federal Reserve, which bought assets through so-called “QE bond purchases” in an attempt to push up asset prices and reduce interest rates. A primary aim was to revive the US housing market, whose crash led to the crisis. The first two doses of QE succeeded in arresting the fall in house prices; they started to rise after QE3 (nicknamed QE infinity because it was originally set to carry on indefinitely) was started in 2012; house prices are now rising firmly, although still below their 2007 levels in real terms.
Looking at stock markets around the world, the US has been a leader, surpassed only by small markets, particularly in Latin America. (Venezuela enjoyed freakishly strong returns). Meanwhile, the eurozone’s sovereign crisis left many countries on the EU’s periphery suffering terrible losses, while Asian markets also tended to lag behind.
What has driven the market? Low interest rates, driven by the Federal Reserve, have prompted US companies to issue far more debt.
That has driven down credit quality, with top-rated AAA-quality companies almost disappearing, while the number of poorer quality credits has risen.
And yet investors have brought perceived credit risk, or the extra spread in the yield corporate bonds must pay to treasuries, down to the tight levels seen on the eve of the credit crisis.
With debt so cheap, companies have taken the opportunity to pay out money to shareholders, by paying dividends or buying back stock. Companies that did this strongly outperformed the market, and the total size of the market shrunk.
Meanwhile, investors still behaved as though economic growth was in short supply. “Growth” stocks, with regularly rising profits, strongly outperformed “value” stocks, which look cheap compared with fundamentals, throughout the decade.
Meanwhile, the US economy slowly returned to life. Sales of vehicles, once boosted by the desperation measure of “Cash for Clunkers” during the recession, have now recovered to their pre-crisis levels.
In the financial industry, hedge funds were the most conspicuous losers. Hedge funds do not benchmark themselves against the stock market, and should not be expected to outperform during a big rally; but most forms of hedge funds have on average lost money for their clients compared with 10 years ago. Macro funds spotted the crisis coming and positioned themselves to profit during 2008; but few managed to adjust to the new environment once the Fed started QE bond purchases and many sustained losses from the eurozone crisis.
Few made what would have turned out to be the best sectoral trade of the decade. Anyone who sold short mortgage companies and thrifts at the market top in 2007 (prices collapsed during the crisis and the sector index was discontinued in 2015), and put the proceeds into the internet retailers who would revolutionise US retailing (led by Amazon), would have turned an initial $100 into almost $20,000.