Why The Stock Market Crash of 2008-2009 Was Not Scary

On page 22/23 of his work One Up On Wall Street, Peter Lynch explained why the stock market declines of 1990 bothered him a lot more than those of 1987: “While the 1987 decline scared a lot of people (a 35 percent drop in two days can do that), to me the 1990 episode was scarier. Why? In 1987 the economy was perking along, and our banks were solvent, so the fundamentals were positive. In 1990 the country was falling into recession, our biggest banks were on the ropes, and we were preparing for war with Iraq.”

When you see the prices of your non-cyclical stocks decline by more than 20%, the subsequent question that you should immediately ask is: Are the dividends and overall profits falling substantially, too?

Outside of the financial sector, the stock market crash of 2008-2009 was not accompanied by a joint decline in the profits of America’s heavyweight corporations. When you look at the cereal makers, Kellogg grew its profits from $2.99 to $3.16, and raised its dividend from $1.30 to $1.43. For General Mills, profits grew from $1.76 to $1.99, and the dividend rose from $0.79 to $0.86.

In retail, Wal-Mart continued to do what it has done my entire life, delivering annual growth by just about every metric imaginable—earnings, cash flow, dividends, sales, etc. Profits during the recession grew from $3.42 in 2008 to $3.66 in 2009, and the dividend increased from $0.95 to $1.09.

Among the no-nonsense blue chips, the results were quite similar. Pepsi grew its profits from $3.21 to $3.77, and raised its dividend from $1.60 to $1.75. Johnson & Johnson grew its profits from $4.57 to $4.63, and the dividend increased from $1.80 to $1.93. At Procter & Gamble, profits remained steady, going from $3.64 to $3.58, and the dividend went up from $1.45 to $1.64.

One of the things that made the recent financial crisis easy to handle (outside of financial sector investments) is that the profits at the non-cyclical blue chips held up well despite lower stock prices. I get what Lynch is talking about when he says that declines in earnings power (i.e. imagine if Coca-Cola’s profits fell by half as its stock price declined by half) are much harder to figure out than stock price declines that do not lead to similar declines in profitability.

In the past 100 years, there have been two times when the earnings power of American companies declined alongside stock prices: The Great Depression, and the Bear Market of ’73. Corporate profits fell by around 50% during the heart of the depression, and they fell by a little more than 25% in 1973. Those are difficult environments because you have to anticipate that profits will eventually return to normal someday, but during the 2008 and 2009 crash, the profits at many of the American stalwarts were actually increasing or remaining nearly constant despite the declines in stock prices. That is so much easier to handle than seeing profits dry up by 50% and trying to figure out whether the decline is temporary or going to become permanent. But if you were a diligent investor that focused on the underlying economic engines of the companies you owned, then the 2008-2009 crisis was the opportunity to make once-in-a-generation purchases because the stocks were cheap, and the earnings power remained strong.

Originally posted 2014-02-03 07:46:56.

Like this general content? Join The Conservative Income Investor on Patreon for discussion of specific stocks!

6 thoughts on “Why The Stock Market Crash of 2008-2009 Was Not Scary

  1. scchan_2009 says:

    Numbers worth a thousand words
    PE for SP500
    2005 – 17.3 
    2006 – 16.8 
    2007 – 16.5 
    2008 – 10.9 
    2009 – 18.6 
    2010 – 15.5 
    2011 – 13.7 
    2012 – 15.0

  2. Joe_G from Seeking Alpha says:

    “Outside of the financial sector, the stock market crash of 2008-2009 was not accompanied by a joint decline in the profits of America’s heavyweight corporations.”

    No, but the simultaneous freezing of credit did threaten the survival of many non-financial corporations.  That’s why non-financials like Dow Chemical, USG and General Electric had to go cap-in-hand to Berkshire Hathaway just to keep the lights on in the short-term.  What made 2008-2009 scary was not the threat to earnings but the liquidity concerns that could kill a company almost overnight.

  3. scchan_2009 says:

    Joe_G from Seeking Alpha I think we have to give Helicopter Ben some credit acted quick to prevent a freeze. I think it is worth noting that central bank response after a crash or crisis can have medium term effects. A reason why the 1929 crash led to the Great Depression is a central bank response to the crash. As people dumped their stocks and go for safe asset – eh… gold, some banks ran out of gold to exchange for fiat. In order to defend the gold standard, central banks RAISED interest rates – exactly what you did not want after a stock market crash. As people remained in panic mode – refuse to spend, refuse to invest, and everyone hoarded cash; and there you go – Great Depression and deflation. Oddly, Helicopter Ben is most well known for his work in Great Depression.

    The punch line, when there is a panic (be at a stock market crash, bank run, ship capsize, fire), the first thing is to calm down and stabilize the condition, and put things into control. Making the panic worse is the last thing to do, and will just make things worse. It is a good thing that we have the Fed backstop, FDIC, search and rescue teams.

    Something to note post-2008, even most company profitability has not fallen (as indicated by SP500 P/Es), the jobless rate and mortgage defaults did shoot up. In the end, the real economy is more than big companies making money. That is why you always need some prudent savings and investment to insure against downturns.

  4. scchan_2009 says:

    Joe_G from Seeking Alpha A more modern example of poor response after a bubble crash is the Japanese lost decades. I know a lot of people hate inflation, but deflation is worse. That is why you want to purchase good assets with free income (oh Tim loves to hear this – laugh).

  5. Joe_G from Seeking Alpha says:

    scchan_2009 Joe_G from Seeking Alpha Agreed.  Bernanke was the right man for the job at exactly the moment when his area expertise was needed to guide the Fed’s actions.  I’m glad that he tuned out all the noise from the usual know-nothing critics who insisted the Fed’s actions were going to “debase the dollar” or cause hyper-inflation (I’m looking at you, Ron Paul).  The only appropriate response to a shortage of credit is to flood the system with cash, which is exactly what QE was all about.

  6. scchan_2009 says:

    Joe_G from Seeking Alpha scchan_2009I don’t think people like to give credit to mess cleaner and damage controller – in fact they often take blame for the mess.

    Why the heck I lost money, Dr Bernake!? (You really want Great Depression or Japanese Lost Decades in America?)

    Why the radiation crew unable to prevent leaks from Chernobyl or Fukushima!? (Imagine the crew actually not doing a thing?? – btw some of the Chernobyl died for doing the clean up)

    Why my flight delayed for 3 hours after blizzard!? (Oh you should be glad your flight actually took off)

    Blah Blah Blah

Leave a Reply