As memories fade and we strain to recall how exactly we got the scars earned by those of us active in this business half a decade ago, a few quick, obvious answers come to mind before we dig beneath the surface: ‘It was the financial crisis, of course! It was the collapse of the housing market, which pushed our interconnected financial system to the brink of dysfunction! It was Lehman!’ Yes, all true, though such simple explanations fail to describe the angst and human emotion so prevalent during the momentous year of 2008. Particularly because, prior to September 15, while a storm was clearly forming and the marks of the upcoming crisis were surfacing everywhere, the stock market was behaving like, well, the stock market. It was swayed by oil prices, unemployment reports, corporate earnings and, of course, the Fed. A look back illustrates not only what was happening in the summer leading to Lehman’s bankruptcy but most relevant to us, how the Barron’s 400 Index was coping at the time.

Following the March acquisition of Bear Stearns by JPMorgan, supported with $30 billion of Fed money, the stock market breathed a massive sigh of relief. It rallied 12% from mid-March to mid-May as the sickest of the investment banks had been triaged for a relatively low price. The market was surely on the mend. As May advanced and further signs of economic weakness materialized, particularly as home prices failed to find a bottom, the jitters returned. A new respite came on June 5 when the Fed announced that it had finally cleared the acquisition of Countrywide by mighty Bank of America, as reported by Barron’s on their Stocks To Watch Blog on June 6:

“It may have had all the drama of a North Korean election, but the Federal Reserve has given its imprimatur to the takeover of Countrywide Financial (CFC) by Bank of American (BAC).”

On Thursday, June 4, B400 closed at 318.98, up 1.1% for the year, better than the -3.3% year-to-date loss for the Dow Jones U.S. Total Stock Market Index. That would mark B400’s high for the year, a level it wouldn’t reach again until December 8, 2010.

The following day the all-important unemployment report for the month of May confirmed what many feared: the U.S. economy was shedding jobs fast and what many hoped would be a relatively isolated housing crisis was quickly infecting everything. ‘The Trader’ column from the Barron’s June 6 issue:

“Is the stock market’s recent resurgence just an ephemeral, bear market rally? The question has worried investors since the stock market’s recent peak on May 19, when the Standard & Poor’s 500 index began to struggle—after having pulled off a 12% rally from its mid-March low. But that nagging doubt turned into palpable fear Friday, after already-oppressive crude-oil prices spiked more than $10 in one day to push toward $140 a barrel, and after the unemployment rate jumped to 5.5% from 5%, its biggest monthly gain in 22 years.”

Looking back today it was this week in June, not the infamous Lehman week of mid-September, when the market began to crumble. Which brings us back to B400; what did it own at the time and how did it fare through the crisis?

Before getting into what B400 owned in the summer of 2008, based on its latest March rebalance, it’s important to note what it didn’t own. Yes, the index had a healthy 11.75% in Financials at the time but not the same ones that were dragging the traditional benchmarks down. This helps explain why, even after the May unemployment report and subsequent market swoon, B400 was only down 1.5% for the year compared to -7.3% for the S&P 500. MarketGrader had long ago downgraded many of the most troubled companies, preventing B400 from selecting them. A few examples appear below:

Additionally, B400 picked, during its March 2008 rebalance, 67 Energy companies, or 16.75% of the index, putting it in a favorable position to benefit from rising oil prices.

The June 5 jobs report focused the market’s mind, once again, on the housing market and the impact it was having on the financial system and the U.S. economy. All eyes were now squarely on the fate of the nation’s toxic twins: Fannie and Freddie. Their gradual collapse slowly unfolded during the months of June, July and August of 2008, while the Federal Reserve instituted all sorts of lending facilities designed to help them, holders of their paper and financial institutions in general whose balance sheets were brimming with mortgage backed securities and their derivatives, until they landed in government conservatorship—essentially wiping out shareholders—a week before Lehman Brothers filed for bankruptcy.

Note from the editor: expect the conclusion of this ‘Five Year After’ series to be delivered to your inbox on Monday, September 16: ‘Lehman Brothers: the End Of the World Live On CNBC’

The latest B400 Diary entries by John Prestbo:

Five Sectors Lead B400 in Market’s Rebound Over Past Five Years
Five years ago, the financial industry imploded. Lehman Brothers and Bear Stearns went out of business; Bank of America absorbed Merrill Lynch, at the government’s behest; Citigroup and AIG were put on taxpayer-funded life support.