The earliest signs of the global financial crisis began to emerge in 2007 and the events that followed are still defining markets 10 years on.

The crisis started when rising number of subprime mortgage borrowers defaulted on their payments, spreading panic through the banking system as their loans had been carved up and repackaged with traditional mortgages to be sold to investors.

Owing to this, banks became wary of lending to each other as they could not work out who was most exposed to these bad debts.

A key date in the crisis was 9 August 2007, when French bank BNP Paribas suspended two funds exposed to the US mortgage market and blamed a “complete evaporation of liquidity”. Over the following months conditions worsened, resulting in the crash of 2007/8.

Schroders’ David Brett said: “Banks failed, government institutions were bailed out, stock markets crashed and countries had to be propped up financially.

“We are still feeling the effects: low growth, political upheaval, Brexit and even the election of Trump can all be traced back to the crisis.”

Over the following pages, Brett talks us through several charts analysing the crisis and the decade since.

The ‘fear gauge’ that shows no fear

VIX index level (%)

Source: Schroders, Thomson Reuters Datastream data as at 30 June 2017

Brett said: “The first inkling that something was wrong should have been seen in the so called ‘fear gauge’. The Chicago Board Options Volatility Index, or the VIX for short, is one measure of sentiment in the market.

“The higher the reading the more likely it is investors believe that there will be a market-moving event, good or bad, in the near future.

“As the chart illustrates, by mid-to-late 2007 the VIX was already at highs not seen since the dotcom bubble in the early 2000s. By early 2010 it had hit an all-time high, by a distance, as the fallout of the crisis threatened the future of the eurozone.”

But as governments and central banks intervened to stem the flow of the crisis the VIX subsided. Confidence among investors grew. The VIX is now at historically low levels. It indicates that investors see nothing on the horizon that will cause extreme market volatility.”

The decline of bond yields

Bond yields (%)

Source: Schroders, Thomson Reuters Datastream data as at 30 June 2017

“One of the most startling effects of the crisis has been the long and steady fall in bond yields. Central banks saw the need to reduce borrowing costs and therefore slashed interest rates and some began programmes of quantitative easing – creating money electronically and using it to buy bonds,” Brett continued.

“This had the desired effect of reducing bond yields as bond prices rose. Bond prices heavily influence wider borrowing costs in the economy, hence the urgency to reduce them. But years after central bank rates were cut, yields continued to fall. New waves of QE were part of the reason but also fearful investors wanted to buy bonds as shelter for their money.

“This became extreme. As the chart shows, Japanese and German bond yields fell into negative territory in 2016. That means rather than receiving interest from a bond, investors were paying interest to own them.

“Japanese, German and UK bond yields remain below 1 per cent, which reflects investors’ view of the outlook for interest rates in those regions. US bond yields have climbed above 2 per cent as the Federal Reserve has begun to raise interest rates.”

How stock markets bounced back

Compound annual growth rate % (CAGR*)

Source: Schroders, Thomson Reuters Datastream data as at 30 June 2017

“During the worst phases of the crisis, Japanese and European stock market indices lost more than half of their value, as measured by the MSCI Japan and the MSCI Europe (excluding UK) indices. World, US and Asia (excluding Japan) indices all fell by more than 40 per cent, while the UK lost over 35 per cent of its value,” Brett said.

“However, the knock-on effect of central bank attempts to stimulate economies has sent stock markets roaring back. US stocks have risen more than 260 per cent since the crisis low in March 2009. UK, European and Asian stocks are all up more than 150 per cent in the same period.

“It is, of course, almost impossible to time the market. Those who sold their investments at the top in the autumn of 2007 and bought back at the low of spring 2009 would have done so more out of luck than judgement.

“But as the chart illustrates even if you had left your money in stocks at the pre-crisis highs in 2007 you would still have made a healthy return, albeit having endured some nervous moments. Between Q3 2007 and Q2 2017 US stocks returned more than 7 per cent per year including dividends. UK and world stocks returned 4.9 per cent and 4.3 per cent, respectively.

“Japan and Europe, which have seen some of the worst economic woes in the last decade, were the two main underperformers, although shares still returned more than bonds. The stock market indices for each indicate returns of 1.26 per cent and 1.35 per cent respectively.”

The sectors that performed best (and worst)

What $1,000 invested in 2007 would be worth now

Source: Schroders, Thomson Reuters Datastream data as at 30 June 2017

“Perhaps unsurprisingly, investors have backed safer areas of the stock market, keen to protect their investments just like bond investors,” Brett said.

“As the chart shows, companies involved in healthcare and consumer staples, those that make household goods like cleaning products and food, would have returned you the most over the last 10 years. A notional investment of $1,000 would have returned $2,089 and $2,039, respectively. Since 2007 investors have preferred stocks that produce goods and services that remain in demand even in times of strife, while providing a stable income.

“The materials sector, which include miners such as Rio Tinto, and the energy sector, home to oil producers such as BP and Exxon, are two of only three sectors that would have lost you money. $1,000 invested in each would have lost you $88 and $193, respectively. Demand for oil and raw materials, such as copper and steel, had slumped.

“The worst performers were the banks which were in the eye of the storm. Some of them collapsed. Others, such as Bear Stearns in the US and HBOS in the UK, were saved by other banks in rushed, cut-price deals. The rest survived but were avoided by investors. A $1,000 investment in the banks sector would have lost $389.”

Is it now safe to invest in banks?

How investors valued banks then and now (price-to-book ratios)

Source: Schroders, Thomson Reuters Datastream data as at 30 June 2017

Brett continued: “Banks were left alone by investors for good reason; no one knew what toxic assets they still owned. However, they have done much to rebuild their businesses over the last 10 years. So, is now the time to re-evaluate the case for investing in banks?

“The chart shows banks’ price-to-book multiple (P/B). It illustrates just how much investors have devalued world banks. P/B compares the price with the book value or net asset value of the stock market.

“A high value, usually above one-and-a-half, means a company is expensive relative to the value of assets expressed in its accounts. A low value, usually below one, suggests that the market is valuing it at little more (or possibly even less, if the number is below one) than its accounting value.

“This link with the underlying asset value of the business is one reason why this approach has been popular with investors most focused on valuation, known as value investors.

“European, UK and Japanese banks have been avoided by many investors. According to their current P/B multiple investors are valuing them at less than the value assets on their balance sheet, compared with 2007 when they were almost double.”

How have equity valuations changed?

How sector valuations compare

Source: Schroders, Thomson Reuters Datastream data as at 30 June 2017

“We have valued each sector using four key tests some investors use before they make an investment,” Brett said.

“We compare their current valuations to their 10-year averages (which are in brackets). We have ordered them in relation to how the sector has performed over the last 10 years. Healthcare is at the top because it has performed best and banks are last because they have performed the worst, with the MSCI World at the bottom for comparison.

“On these key tests you can see that healthcare is looking relatively expensive on all four and is currently paying a lower-than-average dividend.

“Banks, despite their underperfomance over the last 10 years, currently also look expensive across the four tests and are paying lower than average dividends. It illustrates that the performance of a sector is not necessarily a good indication of whether it is cheap or expensive.

“The energy sector is an interesting case. One of the drawbacks of using trailing price-to-earnings (P/E) is that it focuses on the last 12 months earnings. Energy stocks had a stellar 2016, compared to the last 10 years, as the oil price recovered from historic lows, which is the reason the trailing P/E is so high and its average is so low.”

Fund manager view

Government bonds may not be a safe haven this time around

Joe Le Jéhan, a fund manager in Schroders’ multi-manager team, said: “The key to navigating the financial crisis was being alive to the warning signals that were evident across markets in the preceding months. In periods like this, our over-riding aim is to protect your investment.

“If we avoid significant losses, we should be in a position to take advantage of cheaper valuations when the opportunity arises, rather than nursing our wounds.

“We strongly believe that it’s this willingness to actively manage risk that allows investors to compound strong returns over the longer term.

“During the financial crisis, this meant holding very few economically sensitive equities, avoiding areas like financials and using assets like government bonds to provide some upside as most things fell in value.

“Whilst such a concentration on capital protection is vital at the end of all cycles, this cycle has been quite different. So, what we can use to protect portfolios this time may well also differ.

“Government bonds – historically a more obvious safe haven – may not offer the same opportunity this time around. This is why it is worth looking at the few assets that look relatively under-valued and/or have the potential to protect should markets enter another stormy patch.

“These assets might include cash to help dampen volatility and provide that option to invest at cheaper levels when the buying opportunity returns. Selective hedge funds and assets like gold may also have the ability to make money should equity markets fall.”