5 Lessons From the Last Stock Crash

Stocks celebrate with a record rally, but could we be heading for another miserable fall?

NEW YORK - OCTOBER 09: A trader puts his hand on his head on the floor of the New York Stock exchange October 9, 2008 in New York City. After a day in which the markets showed early promise in gains, the Dow fell 678 points, falling below 9000 points at the end of the trading day.
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The best market forecasters did not see the stock collapse coming at this time five years ago. Only the "busted clocks"—the ones that were always bearish—had it right.

"When I went back a couple of years afterward, I couldn't find anyone, anyone who saw what was going to happen, even in August just a few weeks before," says Mark Hulbert, who has been compiling data on investment advisories since the 1980s with his "Hulbert Financial Digest." "Except for a couple of people who are always bearish. Busted clocks, but ... " He didn't finish the line: They are right twice a day.

Five years after the crash, individual investors who shunned equities and bought bonds are finally going back into stocks. With the market moving into record territory, does it suggest no one has learned anything? Not necessarily.

[See Why Dow 14,000 Was One of the Market's Toughest Milestones]

Here are five things we did learn:

1. Staying with allocations is not a bad idea. The fund flow data shows many dumping stocks and loading up on bonds. But that only reflects where the new money went. People still held trillions in stocks they did not sell. With the Standard & Poor's 500 index doubling from its March 2009 low, their stock holdings rose $10 trillion, according to Bloomberg data.

2. Gold and "hard assets" were not better than the paper ones. When stocks collapsed in September 2008, bullion tumbled too, falling 15 percent. It fell less and recovered earlier, but gold has been a relatively poor asset to hold since that time. The popular SPDR Gold Trust ETFshares is up 70 percent since stocks hit their low—just half the gain of stocks, as measured by the S&P 500 (up 140 percent.)

3. Treasuries became the safe haven, but probably not anymore. As every other financial asset plunged in value, U.S. Treasurys leaped. It happened again, ironically, in 2011 when the U.S. government hit its spending ceiling and a shutdown loomed. Even then, unfunded Treasury bills were considered golden. Now, with prices at all-time highs, the worry is that the bond market might be vulnerable to a huge setback as the Federal Reserve's ultra-low interest rate policy ends. (Hulbert says the highest-rated bond forecasters remain "positive" on bonds.)

4. Money market funds were broken. Money market funds have survived, but the favored "safe money" was in deep trouble in the midst of the crash as big investors pulled their cash out. The funds needed government backing to end massive outflows. There is still more than $2 trillion in the funds, which still promise that $1 invested will be worth the same when it is withdrawn. But many now publish the "real" value, which can be lower. The firms still say they will "top up" the funds to make sure the buck sticks.

5. There is no way to eliminate all risk. "Risk is just an inevitable part of investing and that may be the best wisdom you can come to," says Hulbert. Even the safe money can come under threat. The government took emergency measures to insure bank deposits for businesses, and only ended them this year. Individuals still get $250,000 of deposits insured.

[Read: Why Budget Woes and Cyprus Didn't Faze the Market.]

It follows that if risk can't be eliminated from markets, neither can forecasts. In normal times, it pays to listen to well-informed, extremely good guesses made by top forecasters. But the top-rated market forecasters who were most consistently right were no better at forecasting the crash than the lower-rated ones, under Hulbert's methodology.

What is still unknown is what's next. And it's the nature of capital that there are risks. Every change in the global economy can shift the value of financial assets, from currencies and gold to bank deposits. The equity market, meanwhile, tends to offer enough of a premium for its risk by paying about two percentage points of average annual return above other investments, says Hulbert.

The Dow Industrials from the October 2007 peak to lows set in March 2009 might have seen that 2 percent as small compensation. David Edwards of Heron Financial Group, who says a half-dozen big clients fired him during the crash, kept his remaining clients invested in stocks so they got the full benefit of the rebound. But after the big rally this year, he is "a little cautious right now" and is making only incremental increases in stock allocations. "If we did see a 10 percent pullback, we would invest more aggressively," he says in his latest advisory.