Are We Heading for a Repeat of the 2008 Crash?

A number of people are asking: ‘Is Greece the new Lehman Brothers?’

Will a default by Greece freeze up the financial system, just as the Lehman Brothers collapse did, triggering another stock market crash?

In fact so many people are asking it, Matthew Lynn in this week’s MoneyWeek magazine declared it a cliché: Greece is not another Lehman moment – it’s far worse than that (if you would like to become a subscriber, you can claim your first three issues free here). I see what he means, but I have a fairly sensitive cliché detector and I don’t think we’re there quite yet.

Stock markets are behaving badly, there’s no doubt. This feels worse than a normal seasonal correction. But are we headed for a crash?

Today I want to take a look at the chart action of some of the key sectors leading up to the crash of 2008 and compare it to the chart action of the same sectors today, to see if they shed any light on the matter.

Crashes are extremely rare

Even though we’ve had two in the last 11 years, crashes are in fact extremely rare. So the laws of probability suggest to me that crashes are not worth betting on. Greece defaulting will no doubt create problems in the financial markets, but I don’t expect it to freeze up the financial system in the way Lehman did.

Lehman wasn’t the world’s biggest bank, but it was a major component in the global financial network. Being involved in so many trades meant that when it went under, the whole banking system froze. Greece is not involved in the financial system to anything like the same degree.

But a default by the banks that are exposed to Greek debt? Now that’s another matter. This of course, is what much of the noise around the crisis is all about. Policy makers are more concerned about the ramifications of a few leading European banks getting into trouble than they are about Greece itself.

Financials were also the first sector to warn investors of impending disaster in the last crash. In the lead up to the 2008 financial crisis, the financial stocks actually peaked in February 2007. They retested that high in the spring, failed the retest and it was down from there.

The major stock markets – the Dow Jones and the S&P 500 – peaked a whopping six months later in October 2007. The warning came from the financials. They led, and the Dow followed.

Gold was one of the hardiest asset classes during the crash

Interestingly, Canadian stocks – a market I follow closely – peaked in April 2007, before the financials failed their retest. Canadian stocks are closely linked to oil and metal prices, of course, but because many are either exploring for or developing mineral deposits, they don’t actually have cashflow, so are dependent on funding. When liquidity dries up, they sell off. So in many ways they reflect the state of the financial markets as much as they do commodities prices.

Elsewhere, gold made its high in March 2008, six months after the Dow. The last to peak was oil in July of 2008. By the autumn everything was crashing.

But gold made its low in November 2008, as did oil and Canadian juniors. The Dow and the financials carried on falling until March 2009. Gold’s late peak and early rise was a display of comparative strength.

You can see what I have just described in the chart below. It’s a bit of a spaghetti junction, I’m afraid, but I have described above what I see as the key messages to take away. The Dow is the black line, the financials the red line, oil the green, gold the gold (it’s very clear on this chart just how much more durable it was than every other asset class) and Canadian juniors the blue.

(Click on the chart for a larger version)

There’s bad news and there’s good news

The bad news is that this sequence is repeating – at least to an extent – today. The good news is that while I think the correction will continue, we won’t get a repeat of 2008. Hopefully.

This time round, the financials were once again the first to peak, in February. The Canadians juniors peaked a few weeks later, while oil, gold and the Dow all pushed on to new highs, before peaking simultaneously at the end of April. Since June, the financials have stabilised a little, but oil and the Canadian stocks have been in freefall. For all its weakness over the last few days, gold has still been relatively strong.

Here is the same chart of the various markets over the last 18 months. The same colour scheme applies as before.

(Click on the chart for a larger version)

This whole process has happened over a much smaller time period than between 2007 and 2008. That leads me to think that any further declines won’t be as dramatic as those of three years ago.

I’m sure that Europe will somehow manage to fudge its way through this Greek situation, just as it did last year, and put off the great day of reckoning – which we all know is coming – for another year or two. (Although the Greek vote this afternoon might be a little hairy.)

And if things get really bad in the stock market, I’m sure gold’s great allies in the central banks will introduce QE3 or something similar. We’ll just have to be patient. All in all, I’m pleased with the call I made back in March, that we were now in a bear market and to sell any rallies. I just wish I had sold more aggressively myself. But with 20:20 hindsight, we would all be wonderful traders.

I reserve the right to change my mind as events unfold. But I see this current stock market bounce as little more than a dead cat bounce and I’m not sure we’ve yet seen the low. But I daresay we’ll be seeing some great buying opportunities over the summer.