If there was ever a slogan that scares the heck out of seasoned investors, this is it. It is unarguably true—always—because, as Mark Twain observed, “history may not repeat, but it sure rhymes.” It is just as arguably untrue in that things are rarely as “different” as the IDTT crowd wants us to believe. It has been uttered to support bubbles and investor euphoria, and to justify crashes and deeply depressed values, in the face of vast evidence to the contrary.
How many times has reversion to the mean destroyed the wildly optimistic projections accompanying those four simple words? Upon entering the phrase into Google, the first link that pops up is to Amazon.com for "Dow, 30,000 by 2008—Why It's Different This Time” by Robert Zuccaro.1 In the midst of our current market environment, this treatise of unbridled optimism seems like something from a long buried time capsule, an archeological relic of a bygone era, not a work published seven years ago still available for purchase.
A lot can happen in seven years (although perhaps not Dow 30,000.) Perhaps most remarkable is how often, and in what contexts, the phrase “It’s Different This Time” is used today. This time, it’s used to justify extreme pessimism, the death of mean reversion, the folly of rebalancing, and the failure of diversification. Indeed, the second Google link takes you to an LA Times article from March 2008 detailing the parallels between the Great Depression and the then still blossoming financial crisis.2
The same four words plugged into a search engine spit out seemingly opposite headlines—seven years of unprecedented stock market gains and an indefinite period of economic disaster. To a contrarian, the irony could not be any thicker. Pessimistic at the turn of the century, we soundly rejected the IDTT arguments of the day. Today, we find ourselves in an unaccustomed position: we’re optimists in some markets, believing that now is an excellent time to take the long view and allow heightened risk premiums to accrue to investors’ benefit.
Finding the “Walking Wounded” in the Markets’ Carnage
The hoped-for rebound, following the “Take-No-Prisoners” market crash late last year, failed to materialize in the first quarter or 2009. Markets continued their slide in the first quarter of 2009, expanding the losses for investors in virtually all asset classes. Indeed, during February, 15 of the 16 major markets that we track in our Global TAA work fell; the equally weighted portfolio fell nearly 5%. How often had that happened before, going back as far as we have the relevant data? Never … until late 2008. This unprecedented event—15 out of 16 asset classes falling with a –4% average in a single month—happened for the first time ever in September 2008. And repeated in October and again in February—thrice in a six month span. If we exclude last fall, February 2009 would be comparable in breadth (number of positive assets classes) to August 1990 and severity (equally weighted decline) to September 2001; two months that preceded war and major financial uncertainty. Yet, February gets comparatively little attention because it pales next to the carnage of last September–October.
During the 21-month period of this financial crisis (measured July 2007 through March 2009), the equally weighted portfolio of 16 asset classes3 was not spared. With its expanded toolkit, broad diversification, and liberal use of ostensibly uncorrelated alternative markets, this naïve 16-asset-class portfolio added 460 basis points of relative value versus the 60/40 mix (–21.4% versus –26.0%). Clearly, this diversified portfolio failed to keep investors in the black, and we are cognizant that many investors are growing increasingly frustrated that diversification hasn’t provided stronger protection in this crisis. Indeed, it is remarkable in a historical context how relative value between asset classes—a key driver of correlation and diversification—has been thrown out the window.
Consider the performance of investment-grade corporate bonds versus stocks in Figure 1 over two distinct time periods. The first covers September 1929 through June 1932, a period in which the S&P 500 Index cumulatively declined by 84%. We will label this period “The Great Depression.” The second period, which we label “The Great Recession,” covers the most recent drawdown of the S&P 500 (–47%) from November 2007 through March 2009.4