The disaster of 2008 and subsequent lows in 2009 marked the wake-up call of the century. But July 2007 was when the music actually stopped.

It’s for this reason that comparing current prices on securities like EEM and SPY with what they were back when all this started in 2007 can help assess the risk-reward balance moving forward. EEM is basically unchanged from where it was back then, while SPY is about 25 percent below its July 2007 level. That then-and-now comparison is telling us something important and, more generally, I think such comparisons across different asset classes are one of the most overlooked indicators.

So, let’s imagine we’re looking at the SPX chart below in the summer of 2007, meaning the backdrop is that we’re looking at prices at a time when the biggest credit boom in U.S. history—from 1980 to 2007—was possibly coming to an end. To be clear, a critical part of this exercise is to match prices in any given period to the macroeconomic factors that prevailed at that time.

I did this exercise in the summer of 2007—of course not realizing what would happen just over a year later with the collapse of Lehman Brothers and near implosion of the global banking system. But I do remember thinking, as I looked back in time, that if the 2001-2002 recession had forced the Federal Reserve to cut rates to 1 percent to revive economic growth, the next recession might be worse and the central bank might have to cut short-term rates even more the next time—maybe even down to zero. Truth be told, even I laughed at the idea at the time, and pretty much put it out of mind.

Now that rates are actually zero and the Fed’s balance sheet has doubled, I think it would be wise to revisit this line of thinking a little more seriously this time.

The 2002-2007 Example

In order to get to the present, it’s necessary to know where we came from. Minus the obvious flaw of using hindsight, looking at some of the tangible economic drivers from 2002 to 2007 in conjunction with the S&P 500 price behavior gives us a framework to work with.

To keep things simple, I used conservative back-of-the-envelope math integrating house prices appreciation, job creation and the stock market rally to estimate about $13 trillion in new equity that was created during that period. These three elements together created a positive feedback loop with one another made possible by low interest rates, securitization of all kinds of debt, and easy lending standards, to name a few.

I mentioned these drivers in particular because all three are directly related to future equity creation and, importantly, are now either stagnant or moving lower. Much of the temporary wealth or equity they created was thanks to a lot of leverage. Much of that wealth created then has, of course, been destroyed, but the leverage and debt remains.

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