Eight lessons from previous crises that apply today
We reflect on previous financial crises, how they have profoundly changed the market landscape and what insight we can apply to the current crisis.
The first thing it’s important to do is, we need to define what we mean by a crisis in an investment context. We would describe a crisis as a period that leads to a major structural reset in policy and behaviour at a government, corporate and consumer level. This goes beyond a temporary dip in markets resulting from a short-lived event (such as the Iraq war, a terrorist attack or a trade war) – it is something that has a far more prolonged impact on stock markets.
For example, two of the most recent crises are the Asian Financial Crisis in 1997/98 and the Global Financial Crisis (GFC) in 2008/09. We see Covid-19 in a similar vein to these two previous events – as a crisis that will likely have a lasting long-term structural impact on economies and stock markets.
So, what are some key lessons from the Asian Financial Crisis and the GFC that we can apply today?
1. Change your mindset.
This is not about just picking up your old favourite companies at fair value. During a crisis you need to start from scratch. You need to recheck the investment case completely given the structural changes in the environment. Scenarios must be rerun and fair values challenged and reset for new assumptions. Worst case scenarios need to be reassessed – you should not just think outside the box but should try to think the unthinkable.
2. Forget focussing on near-term profitability.
Profits are just an accounting treatment at the best of times. Instead, focus on the balance sheet and cash flows. Debt can be lethal in a crisis, even in small doses. So, the structure of debt including maturity, covenants and the identity of the lenders are key. Never underestimate how impatient some banks can be. During the Asian Financial Crisis many businesses went bankrupt - not because they didn’t have a sound business, but because banks (especially those operating outside their home markets) refused to roll credit lines.
3. Be wary of most bank shares.
Banks by their nature are the most leveraged businesses listed on stock markets. Leverage and a crisis don’t go well together. Banks are also people businesses, and in Asia state-owned banks and weaker family-run banks don’t necessarily attract the most skilled people. Navigating a business though a crisis needs a good management team – organisations heavily influenced by nepotism and internal politics are not likely to pull together well. In addition, even for better banks, non-performing loans will come with a lag (as will the rights issues), and on top of this, in a crisis banks can become political hot potatoes. As the GFC and Asian Financial Crisis proved, with a few exceptions, weak banks tend to disappear/become zombies (see lesson 6 to learn more about ‘zombies’) and even the better banks are slow to recover.
4. Countries with strong institutions tend to recover more quickly.
Good, coherent government and a well-run civil service will tend to mean confidence is restored faster and business can return to normality quicker. During the Asian Financial Crisis it was Hong Kong, Taiwan, Australia, Singapore and Korea that recovered the quickest, whereas Indonesia, Malaysia, Thailand and the Philippines, with less capable governments and less coherent policy responses, almost collapsed completely. A crisis isn’t necessarily a moment to be brave when investing.
5. Disruption accelerates during a crisis.
Necessity is the mother of invention. A crisis often allows out-of-the-box thinking to come to the fore and can break down barriers to change. New disruptive players can emerge in a stronger position and incumbents can be shaken from their lethargy. A crisis can rapidly accelerate the process of creating winners and losers. We are seeing signs of this today amid the COVID-19 crisis, with massive disruption potentially about to hit. This could include:
- The end of 9-to-5 office working week and mass commuting
- A structural move to working from home
- Online healthcare
- Online education
- Less business travel
- Automation and onshoring of production
- A move to a much more virtual world as artificial intelligence (AI)/5G/Millennials/Generation Z come into the ascendancy.
For investors, a crisis means we need to review all our investments as disruption accelerates. What is the future of commercial property, banks, airlines, infrastructure owners (i.e. those companies with large fixed assets) in a crisis-driven, disrupted world? Our past experience of crises suggests many companies’ business models need to be reinvented if they are to survive. Nimbler, asset-light companies often do better.
6. Zombies will rise.
In a crisis, governments will often intervene to stop markets clearing, especially in those sectors deemed “strategic”. This often leaves lots of zombie companies. Zombie companies are able to continue operating by servicing debt however are unable to pay off their debt. This was the case for Korean shipbuilders, Thai property, Korean construction sector and most of corporate Malaysia post the Asian Financial Crisis. The lesson for investors is to avoid investment in sectors that don’t “clear” or haven’t been allowed to clear by governments.
7. Always buy a good business at a fair price.
When you have done your analysis and decided which businesses are likely to come out of a crisis stronger, don’t be overly greedy on the price you are willing to pay for it. The key is to not continually reduce your desired entry level if the share price gets to your initial target, unless the facts and the investment case have changed.
8. The impact of a crisis can linger for longer than you think.
After the GFC the sluggishness of corporate investment, increased populism and a desire for less free market capitalism have all been permanent features. After the Asian Financial Crisis, an aversion to debt became permanently ingrained across much of corporate Asia. This should be positive for the Asian corporate sector during the current crisis. Asian corporates are typically less heavily geared than those in the West (such as in Europe and North America), so hopefully can weather the storms better.
However, because a crisis is structural it often takes a lot longer for stock markets to recover than at other times. Stock markets can remain vulnerable and investors twitchy, particularly if, as highlighted above, a crisis accelerates disruption, creating winners and losers.
You shouldn’t feel the need to chase market rallies during a crisis, unless you believe the bulk of the crisis period has passed.
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