Going forward, investors should keep a careful watch on four realities that are consequential for the configuration of risk-adjusted returns in various markets.
First, global economic activity has fallen off a cliff since September, and will continue to do so in the next few months regardless of what governments do. Second, many investors have experienced large portfolio losses that will erode their risk appetite for some time.
Third, notwithstanding the headline-grabbing stories of 2008, we are just at the beginning of a messy multi-year phase of institutional change in the financial markets that will ripple through many other sectors and companies. Fourth, driven by a genuine desire to compensate for cascading market failures, governments will intensify their involvement in markets through "unorthodox measures" that have both intended and unintended consequences.
All four factors suggest that conventional mindsets and models will be challenged in 2009, just as they were in 2008. As a result, investors are still vulnerable to costly mistakes, especially as there is no lack of seemingly cheap assets out there. They range from illiquid government instruments to highly leveraged equity products. Yet, only a subset will come back; and even fewer will do so in the first part of 2009.
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