In the third part of our series marking the 10-year anniversary of the collapse of Lehman Brothers, investment industry experts give their opinion on the likelihood of another major crisis and whether the market has learned from the mistakes that led to the 2008 crash.
Nick Clay, lead manager of Newton Global Income fund at BNY Mellon
It takes fortitude and a willingness to suffer to break an addiction. It is clear that, 10 years on from the collapse of Lehman and the ensuing global financial crisis, neither of these traits have been present. Instead, the opposite is true; we have learned nothing and the addiction has simply intensified.
Global debt, both in the developed and developing world and whether in its government, financial, consumer or corporate iteration, has grown meaningfully since the crash.
We have learnt nothing and the addiction has simply intensified
Instead of facing up to the hardship of the misallocation of capital leading up to the crisis, global quantitative easing has simply perpetuated the addiction to greater levels of “easy money”, via low rates and an abundance of liquidity.
Further, the support for the debt remains based largely upon asset values rather than an ability to pay, which has striking similarities to the housing bubble that precipitated the crash. This reliance upon upward-only asset values is now about to be put to the test again, as QE transitions to quantitative tightening.
If it is actually possible to withdraw the previous 10 years of stimulus without causing the next crisis, then we are about to find out whether QE is the de facto new policy tool of central banks to be used in the future. If, however, QT exposes the unsustainable nature of this addiction, then we will realise we have learned nothing.
Anthony Rayner, manager of Miton’s multi-asset fund range
Aggressive easing of monetary policy did limit the initial impact of the sub-prime crisis on real economies. Nevertheless, and this is one of the primary lessons, the unintended consequences of these actions have been extreme: material distortion across asset classes, with most asset classes pushing higher.
It also contributed to widening inequality across societies, as those who were asset-rich benefited relatively more. In turn, this has added to the pressure on politicians, and their failure to reduce inequality has been expressed through the rise of populism: Political risk is back on the radar for financial markets.
Political risk is back on the radar for financial markets
As central banks move from QE to QT, we have to understand what this means for asset classes. Assuming QT continues, we would expect zombie companies and economies to continue to be found out by higher interest rates; a number of emerging markets have been pushed into crisis this year.
In terms of the next crisis, the only thing we know for sure is that it will happen at some point.
Yes, interest rates are rising, but they are rising gently and central banks are only too aware of the potential for a negative feedback loop from unstable financial markets into real economies.
Colin McLean, managing director of SVM Asset Management
We should never underestimate the drive for continued economic growth. Politicians will go to extraordinary lengths to patch over banking problems. The US is unlikely to bail out the derivatives market again, and risks remain. Some major eurozone banks have not deleveraged to the extent that US banks have, and even lag the UK. But the response to the last crisis has created precedents for central bank action.
The next crisis does not look immediate
The next crisis does not look immediate, but the catalyst may be illiquidity. Patchy liquidity and lack of clear pricing already effect many asset classes, including emerging markets, infrastructure, real estate, hedge funds and bonds.
In the latter stages of the reach for yield, with little opportunity in a flat yield curve, some investors are increasingly sacrificing credit quality and liquidity for additional return.
Some regulatory change, such as Mifid II, has not helped liquidity, and limits the response of investment banks and fund managers in a crisis.
Now there are fewer short positions to help stabilise the market after a fall.
Michael Hughes, senior vice president at GuardCap Asset Management
The global financial crisis started and finished with the banks. The past 10 years have been marked by serious efforts to improve the banks’ capital ratios and through stress testing to ensure that the experience is unlikely to be repeated. But, at their heart, banks remain a difficult thing to invest in – opaque in their accounting and heavily leveraged into the economic cycle.
Small, exciting sounding, leveraged companies are not a safe place to invest your money.
Banks remain a difficult thing to invest in
While some of these may do well while economic conditions are good, many speculative start-ups in fashionable sectors simply won’t survive if the going gets tough.
The current interest in small companies involved in new, exciting technologies with shaky balance sheets and limited profitability has a familiar ring. Our strategy has always strongly outperformed in periods of falling markets, because we only ever invest in companies that have downside protection “baked” into them.
We only invest in companies whose fortunes are tied to secular, rather than cyclical growth trends, which means they won’t get knocked off course if there is an economic downturn.
We only invest in large, diversified, well managed, cash generative companies, which usually have net cash on the balance sheet, because they will withstand a poor economic environment, but can also outperform in rising markets.
And we don’t invest in companies that are overvalued, because they are usually the ones that are hardest hit when the bad times come.
Lisa Chai, senior research analyst at ROBO Global
A key takeaway from the past 10 years is that people — not just at Lehman Brothers, but across the entire financial services sector — were being rewarded and incentivised using the wrong metrics.
Some activities were clearly nefarious but in many cases it seems neither the institutions nor their employees realised how detrimental that error would be to consumers.
Unfortunately, that means that, despite new regulations and myriad checks and balances, history could potentially repeat itself.
There are few indicators of a pending crash
What is the answer? One solution is the application of artificial intelligence. Today, AI is enabling intelligent systems that make it possible for organisations to detect risks and prevent fraud quickly and effectively. We are still learning, but with AI’s help, our ability to identify and correct issues both inside and outside an organisation is rapidly increasing.
Despite volatility that has many investors on guard, there are few indicators of a pending crash. Price-earnings ratios are continuing to decline and US economic factors and earnings growth remain relatively strong.