15 years since Lehman's: from 5% to 0.25% and back
Interest rates have gone full circle since Lehman Brothers' bankruptcy 15 years ago helped trigger the Global Financial Crisis. With the help of seven charts we look at what else has changed since then, and ask what comes next.
Lehman Brothers filed for Chapter 11 bankruptcy protection in the US on 15 September 2008 in an event that helped spark the Global Financial Crisis.
From a UK perspective, Lehman’s UK businesses went into administration on the same day and UK bank shares plunged. Within months both HBoS and RBS had changed hands as the UK banking sector was recapitalised with taxpayer support.
UK interest rates fell 90% over the next six months from 5% to 0.5%. Only in July this year did the Bank Rate return to 5%.
The following charts reveal some of the powerful trends that shaped the global and UK investment landscape in the 15 years since. And, with interest rates now back at pre-crisis levels, we ask: what next?
UK investors have gone global
There’s been a dramatic shift between 2008 and today in where UK investors invest. The domestic bias has been turned on its head, with substantial outflows from the IA UK All Companies sector, while the IA Global sector has grown exponentially.
In 2008 the AUM of the IA Global equities sector was £11.7 billion, compared to £266 billion today. Meanwhile, despite strong overall market performance, the AUM of the UK All Companies sector has gone from £95 billion to just £97 billion over 15 years.
The charts below show how the tide has turned away from UK equities since the Global Financial Crisis.
Tech dominance: the rise of growth stocks in more than a decade of near-zero rates
With interest rates at or near zero investors were forced into riskier assets, particularly equities, to get the returns they needed.
Growth stocks, in particular, benefited. This is because when investors calculate the value of a company’s future cash flows, the “discount rate” plays a crucial role. In short, the lower the discount rate, the more valuable a company’s future profits are. So, in an environment where interest rates and government bond yields are at or near zero, a company’s future potential profits are highly valued. Hence the appeal of fast-growing companies such as the tech giants. The result is a remarkable dominance of these growth companies in indices.
As the chart below shows, the “Super-7” US stocks now make up more of the global equity index (MSCI ACWI) than the whole stock markets of Japan, the UK, China and France combined.
Ultra-low interest rates have driven property values up (and affordability down)
Low interest rates kept mortgage payments relatively affordable, even for those borrowing large amounts. The result has been rising property prices, with the average house in the UK now costing around eight-times average earnings, based on data as at 30 June 2023.
Looking at 178 years of data, we can see that – before recently - the last time house prices were this expensive relative to average earnings was in the year 1883, 140 years ago. (Read more in my colleague Duncan Lamont's analysis here).
UK house prices as a multiple of average earnings
Companies have been turning away from the stock market as they look to private capital
The declining popularity of stock markets as a way for companies to raise capital is a global trend, but it is particularly notable in the UK and one that has continued in the past 15 years.
In 1996 there were over 2,700 companies on the main market of the London Stock Exchange. By the end of 2022 this had collapsed to 1,100 – a 60% reduction.
One important reason why companies have turned their back on a stock market listing is that another source of financing has become more widely available: private equity.
Private equity has grown from a $500-600 billion industry in the early 20002 to be worth more than $7.5 trillion in 2022. With this growth, the size of the cheques the industry can write has soared. It can now finance companies to a much later stage of their development than before.
Companies are not only attracted to private equity for the money. The best private equity investors also have deep sector expertise and take a much more hands-on approach to driving value. They are sought after by investors and companies alike.
Global government debt has ballooned
Depressed interest rates not only made it cheap for consumers to borrow; governments took advantage too.
Figures from the IMF show that the government debt to GDP ratio for the Advanced G20 nations climbed hugely post the Global Financial Crisis, and surged further as a result of the Covid-19 pandemic. The ratio reached more than 130% in 2020, an increase of over 20 percentage points when compared to pre-pandemic levels in 2019. Government support through furlough schemes, fiscal transfers to households and the roll-out of vaccines account for much of the increase.
Pandemic and energy crisis have driven government debt to new highs since the GFC
What next for investing?
Johanna Kyrklund, Group CIO and Co-Head of Investment, Schroders:
“Investors should expect higher inflation and tighter economic policy for longer. Gone are the one-way streets of “FOMO” equity markets dominated by the US and vanishingly small bond yields. It’s time to return to careful analysis of winners and losers among companies – not just in the US – and seeking interest rate opportunities as monetary policy diverges once again many ways, as an investor you now need to think about what you did in the last decade – and then do the opposite.”
Doug Abbott, Head of UK Intermediary, Schroders:
“Although interest rates have gone back to where they started, the world is very different to how it was pre-Lehman Brothers’ collapse. It’s become a more complex place, increasingly shaped by huge forces such as decarbonisation, a retreat from globalisation, technological advancements and challenging demographics.
Meanwhile, here in the UK, the number of publicly-listed companies has shrunk, leading investors to increasingly looking beyond our shores and to private markets for investment opportunities.
Every asset has had to reprice to compete with a yield on cash in the bank. Valuation matters once again. Compared to the last 15 years, you may now need to be more flexible and active in the way you invest.”
Simon Adler, Value Fund Manager:
“The direction of interest rates occupies a lot of people’s headspace: when rates were at zero post 2008 everyone thought they’re staying at zero forever; now they’re higher everyone’s debating whether the next move is up or down.
As a value investor I’d rather just focus on finding cheap companies with good balance sheets that have the ability to recover.
If you invested £10,000 in a basket of cheap companies in 1926 and consistently bought the cheapest shares over the period your investment would be worth over £1 billion today.
Over this period, we’ve seen seismic changes like a World War, a doubling of life expectancy, the rise of Japan and China, all sorts of different interest rates and much more, but what has remained consistent is that great investment returns have come from investing in cheap companies.
The extremity of the difference in valuation between value shares versus growth remains as extreme now as it was at the peak of the dotcom crisis. And following that value was where investors generated outstanding returns.
So, we’ll see it all kinds of events over the next 15 years, including many things nobody can predict. But I think that analysing and buying cheap companies will remain one of the best ways to achieve good investment returns.”