Last week we saw how the main asset classes are behaving during the coronavirus crisis. So far diversification is working just as if our predicament were a textbook exercise, rather than an ugly reality.

But what about the last time we went down the tubes? What asset allocation lessons can we learn by studying the Global Financial Crisis (GFC)? Did the same patterns play out and does that tell us anything about our fate this time?

Below I’ve tracked that market crash using the Exchange Traded Funds (ETFs) that were available at the time.1

All the ETF returns data and charts come from the excellent portfolio-building service JustETF. Returns include dividends but not inflation.

World equities peaked on 12 October 2007.2 They hit the bottom 17 months later on 6 March 2009.

It wasn’t until 9 March 2010 that equities climbed out of the hole – nearly two and a half years after their fall began.

100% equities during the Global Financial Crisis

World equities during the Global Financial Crisis

(The little D flags at the bottom of the graph refer to dividend payments)

The GFC was one of the worst crashes on record, but it was a fairground ride in comparison to the first month of the coronavirus slide.

In 2020 we dropped like an anvil tied to an anvil: world equities plunged 26% from 20 February to 23 March. It took a whole year for world equities to tumble that far in 2007 to 2008. After the first month, equities had only slipped 7.5%.

In 2020 there is already talk about whether we’ve missed the great buying opportunity or whether there will be more downward legs to come.

There was certainly plenty of pain ahead of us at this point in the GFC. World equities closed just 1.5% down on 19 May 2008, only to trough out at -38% on 6 March 2009. Few were predicting we’d touched the bottom, even by then.

Volatility was wild, too – drops of more than 10% in a week, as confidence drained out of the economy in October 2008.

Equity correlations ‘go to 1’ in the Global Financial Crisis

Equities go to 1 in the Global Financial Crisis

What about a diversified portfolio? How did other allocations do when everbody was making their way not-so-calmly to the exits in the GFC?

In a global crisis nowhere is safe. And so once again there was nowhere to hide in equities.

Just like this time, the financial services exposure of the London Stock Exchange hit UK equities especially hard. Commercial property took a beasting in 2007-10, too.

Emerging markets did relatively well initially, again echoing the early stages of the coronavirus crisis. But as the recession took hold from September 2008, the fearsome volatility of emerging markets dunked them down by nearly 50%.

Mind you that same volatility eventually catapulted them back. Emerging markets were more than 12% higher by 9 March 2010. The developed world was still hovering around 0%.

Emerging Markets (Orange line; ticker: IEEM)

  • Low point: -49.43%, 24 October 2008 vs World -30.2%
  • 6 March 2009: -42.32% vs World low -37.96%
  • 9 March 2010: 12.38%

Global Property (Red line; ticker: IWDP)

  • Low point: -56%, 6 March 2009
  • 9 March 2010: -8.96%

UK FTSE 100 (Blue line; ticker: ISF)

  • Low point: -44.78%, 5 March 2009
  • 9 March 2010: -9.05%

Flight to quality: government bonds in the GFC

Gilts negatively correlated with World equities during Global Financial Crisis

When we look at bonds versus equities on a bear market chart, the picture we hope to see is a mountain range reflected in a lake. When the plunging valleys of equities are mirrored by bond peaks, we know our losses are to some degree off-set.

Intermediate gilts (a blend of short, medium, and long-term UK government bonds) lived up to their safe haven billing during the GFC. You can see that gilts were broadly negatively correlated with equities for the duration of the panic. During most of the big equity sell-offs, gilts pitched in the opposite direction as investors sought refuge in safer assets. That’s the famous flight to quality.

Unlike in the early stages of the coronavirus crash, gilts didn’t turn negative, either, bar an irrelevant -0.1% day on 15 October 2007.

Unfortunately I don’t have any data stretching back to 2007 for long or short-term gilt ETFs.

However their returns would have reliably sandwiched the intermediate gilt ETF’s – long-term gilts doing even better, while short-term gilts provided only crumbs of comfort.

Intermediate UK gilts (Blue line; ticker: IGLT)

  • High point: 20.28%, 8 October 2009
  • Low point: 0.85%, 13 June 2008
  • 6 March 2009: 18.56% vs World low -37.96%
  • 9 March 2010: 16.3%

Inflation-linked gilts and corporate bonds – not so effective in a crisis

Linkers and corporate bonds during the Global Financial Crisis

Inflation-linked gilts and investment-grade corporate bonds have performed poorly relative to conventional gilts so far in the coronavirus crash, just as we’d expect.

Corporate bonds didn’t do us any favours in the dark days of 2008-09, either. That’s hardly surprising – they were backed by companies that many feared wouldn’t survive as the Great Recession laid waste to the economy.

Inflation-linked gilts (‘linkers’ to their friends) outstripped conventional gilts for the first year of the GFC. But they sold-off once deflation became the chief concern. Central banks tried to jolt the economy back into life with their QE defibrillator. That led to talk of runaway inflation, but linkers still lagged as the balance of risks suggested the patient was more likely to lapse into a coma.

Index-linked gilts (Orange line; ticker: INXG)

  • High point 1: 15.26%, 1 September 2008 vs gilts 6.72%
  • High point 2: 18.49%, 30 November 2009
  • Low point: -1.33%, 8 December 2008
  • 6 March 2009: 7.17% vs gilts 18.56%
  • 9 March 2010: 14.85%

Linkers bore up (though not as well as conventional gilts) even as the market rock-bottomed on 6 March 2009. Their inflation-fighting capabilities make them an important part of a passive investor’s load-out even though we haven’t witnessed rampant inflation in the developed world since the early ’80s.

Sterling corporate bonds (Blue line; ticker: SLXX)

  • High point: 5.67%, 18 January 2010
  • Low point: –20.46%, 26 March 2009
  • 6 March 2009: -13.93% vs World low -37.96%
  • 9 March 2010: 5.17%

Gold had a good crisis

Gold and gilts diversification during the global financial crisis

It was gold’s time to shine during the GFC – so much so I’d have been tempted to put a few of my highest carat teeth onto the market.

The yellow metal is proving to be a good diversifier during the coronavirus crisis, too.

Gold is the one accessible, low-cost asset that demonstrably traces a different path from equities and bonds. Long-term returns may be low, but it was worth its weight in 2008-09.

Gold (Yellow line; ticker: PHAU)

  • High point: 102.39%, 3 March 2010
  • Low point: 0.14%, 22 October 2007
  • 6 March 2009: 77.19%

Note that gold can be as horribly volatile as equities. It lost 20% in the week of 10-17 October 2008 while equities bounced along the bottom. Gilts didn’t help much that week either, but at least they only shed 0.5%.

Diversified portfolio vs 100% equities

A diversified portfolio during the global financial crisis

You know the drill. The 100% equities portfolio (green line) is pitched above against a diversified portfolio comprising world equities, intermediate gilts, and gold (blue line).

This diversified portfolio is:

  • 60% world equities (Ticker: IWRD)
  • 35% intermediate gilts (Ticker: IGLT)
  • 5% gold (Ticker: PFAU)

As the chart shows, when an emergency hits you’ll probably be glad you packed your parachute, inflatable arm-bands and fashion-forward face-mask. Your portfolio should be ready for anything.

Take it steady,

The Accumulator

  1. The ETFs I used for last week’s post didn’t exist in 2007.
  2. As tracked by the iShares MSCI World ETF; Ticker: IWRD.

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