Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.
Five years ago to this day, on Sept. 15, 2008, investment bank Lehman Brothers filed for Chapter 11 bankruptcy protection in New York court. As I wrote on Friday, "the bankruptcy -- the largest in U.S. corporate history -- sent a debilitating shockwave through the financial markets and the global economy, and was one of the ... defining moments" -- if not the defining moment -- "of the financial crisis."
The following five graphs, each of which covers a 10-year period centered on the bankruptcy, sum up the state of the recovery, five years after this traumatic event.
Volatility and fear have subsided
Volatility, as measured by the CBOE Volatility Index (^VIX 3.11%) (blue line), exploded to unprecedented levels in the wake of Lehman's collapse, reaching an all-time intraday high of 89.53 little over a month later, on Oct. 24, 2008 (for reference, it closed at 14.16 last Friday). The VIX, Wall Street's "fear index," is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days.
Since then, volatility has returned to pre-crisis levels, all the while suffering some spikes along the way, during specific sub-crises (European sovereign debt crisis, U.S. federal borrowing capacity fiasco, and so on). Note how closely the "fear index" tracks the St. Louis Fed Financial Stress Index (red line), which measures the degree of stress in financial markets.
U.S. stock market: Back at new highs ... nominally
The blue line, which tracks the S&P 500 (^GSPC +0.80%), shows the dramatic decline in stock values in the months following the bankruptcy, during the fourth quarter of 2008 and the first quarter of 2008. Between the Friday before Lehman's failure and the stock market bottom on March 9, 2009, the S&P 500 lost 46% of its value.
However, the index has now surpassed its October 2007 high -- if we neglect to account for the effect of inflation. Indeed, the dotted red line, which represents the S&P 500 on an inflation-adjusted basis, remains slightly below its 2007 high.
The same graphs for the narrower, price-weighted Dow Jones Industrial Average (^DJI 0.16%) would tell the same story.
Economic activity has recovered, but it remains below its potential
The blue line tracks real gross domestic product. The substantial decline in economic activity during the fourth quarter of 2008 (real GDP fell at an annualized rate of negative 8.3%) figures prominently in the center of the graph. Note that the horizontal gray bar represents the recession -- at 18 months, the longest one since the Great Depression.
Economic activity has picked up since then, with GDP surpassing its 2007 high. Nevertheless, it remains below real potential GDP (red line) -- the CBO's estimate of economic output if labor and capital were firing on all cylinders (i.e., if the capacity utilization rate were high). That leads us to the following observation, regarding the slack in the labor market.
Unemployment: still improving, still too high
Unemployment (blue line), which stood at 6.1% in September 2008, rose quickly in the wake of the bankruptcy, topping out at 10% 13 months later, in October 2009. This was the highest jobless rate the U.S. had suffered in a quarter of a century; unfortunately, as the graph illustrates, that rate has been much slower to improve than it was to deteriorate. Last month, the unemployment rate came in at 7.3%, still substantially above where it was at the time of the bankruptcy.
Another ill effect of the crisis: The long-run natural rate of unemployment (red line), the "base rate" of joblessness that is not linked to changes in economic activity, has risen.
Lehman + 5: The Fed wind-down begins now
The preceding graph shows that the monetary base has nearly quintupled since Lehman's bankruptcy, a result of the Fed's money-printing munificence (the Adjusted Monetary Base is "the sum of currency (including coin) in circulation outside Federal Reserve Banks and the U.S. Treasury, plus deposits held by depository institutions at Federal Reserve Banks").
Next Tuesday, the Federal Open Market Committee convenes for its two-day policy meeting. The consensus view is that the FOMC will begin to slow its printing presses by reducing the size of its monthly bond purchases.
While the Fed implemented multiple rounds of quantitative easing to stave off deflation and spur investment and economic activity, the ensuing size of the Fed's balance sheet -- $3.7 trillion, as of last Wednesday -- is a genuine risk factor. The Fed ventured into uncharted waters with these experimental policy measures, and bringing the ship about without hitting (or, in this case, provoking, for a correct analogy) rough waters is no given.
