Taking stock of the lost decade

Written by Sunil Kewalramani | Sunil Kewalramani | Updated: Dec 29 2009, 08:36am hrs
US stocks were the worst asset class over the past decade with an abysmal 0.1% 10-year annualised total return, the worst performance in 200 years. US stocks provided lower returns than cash while emerging market stocks returned over 10% and commodities over 7%.

Wall Street is on track to achieve its first annual advance in two years after staging a strong comeback from the March lows. But viewed in the context of the last decade, investors have little to cheer about. The benchmark S&Ps 500 is down about 10% over the last 10 years, which puts Wall Street on course to register its first-ever negative decade on a total return basis, even with dividends reinvested.

Even the Great Depression in the 1930s, which followed the stock market crash in October 1929 and spanned one of the worst periods for stock investing, turned out positive as dividends helped investors cushion some of the turbulence. But, excluding dividends, the S&P 500 Index shows a drop of almost 25% this decade, compared with a gain of more than 300% over the 1990s.

Since 1900, the Dow Jones Industrial Average has declined in price (not total returns) in just two decadesthe 1930s and the 2000s. The Dow is currently down 9.2% since the end of 1999. In the 1930s, the index fell 39.5%. The best decade was the 1990s (known as the Roaring 1990s) when the index rose 317.6%.

In both the 1980s and the 1990s, the broad S&P 500-stock index provided a total return (which includes dividends) of more than 400%. The total return for the S&P 500 since New Year 2000 has been negative 10.8%.

This decade in markets has been turbulent to say the least. The markets have absorbed the technology boom, ending the effects of the September 11, 2001, attacks in the US and the subsequent invasions of Afghanistan and Iraq. Markets recovered and were inflated by the boom times of high house prices and record corporate results only to be shocked by the credit crunch, sending indices around the world sharply lower and instilling fears of a second Great Depression in the hearts and portfolios of investors. But the 2000s ended on a hopeful note that recovery had firmly taken hold and growth would continue.

Even if we take the indices having remained flat over the last decade, individual pockets of strength were clearly visible, in view of individual companies that have done well in each part of the world.

While the 2000s have been the worst decade for US stocks in 200 years, its been a somewhat better decade for the Global Market Index (GMI), a passively weighted mix of all the major asset classes that one can invest in. US stocks were dead last year, returning a trifling 0.1% on an annualised basis for the past 10 years. By contrast, the best performer among the major asset classes have been emerging market bonds, which soared by an 11.5% annualised total return. As for GMI, it returned 4.2% over the past decade.

GMIs more or less middling performance isnt surprising.

As a market-weighted asset allocation of all the major asset classes, GMI embraces the worlds assets as they are. It is a nave benchmark of everything, presuming nothing other than the idea that theres some degree of embedded wisdom in the valuation of assets as collectively assigned by investors.

History is on our side

The good news is that different asset classes dispense different messages at different times. In other words, a relatively potent signal about future risk and return may be reflected in one or more asset classes at any point in time, which provides a basis for adjusting the passive asset allocation. That was certainly true at the end of 2008 and early this year.

There is always a bull market somewhere, so you can always make money on something, but it takes a lot of hard work, thinking and interest in the markets.

For the trailing decade using December 20, 2009, as an end point, I arrive at a marginally negative return for the S&P 500 index assuming an average dividend yield of 2.5% for the period.

Certainly the negative return would be pronounced by any fees, commissions or taxes related to a 10-year buy-and-hold strategy of the broad market index. But history is on our side, lending support that stock returns have a good chance of improving on the results over the previous 10 years.

The bubbles and scandals that have blanketed corporate America over the last 10 years have made the average investor extremely sceptical. What does this mean for the pricing of risk Well, if you rewind to the year 2000 when technology exceeded 50% of some indexes, and many investors thought technology was a low- risk endeavour, there was virtually no equity risk premium discounted into many stock prices.

If you fast forward to today, the reverse is occurring. Investors despise market volatility and arguably demand a much higher risk premium for taking on the instability of stocks. This is the exact environment investors should desirelots of scepticism and money piled into bonds. Stocks are climbing a wall of worry. As Warren Buffett says, Be fearful when others are greedy and greedy when others are fearful. I believe the next 10 years will be a time to be greedy.

The reason why passive investors in the US have not made much money over the past decade is because they did not diversify enough into international stocks, and they continue to suffer from a home bias. To every investor, I advocate a broadly diversified portfolio across asset classes (including bonds), geographies and styles. However, in managing bonds across portfolios, I am forced to tactfully include strategies such as inflation protection and shorter duration techniques. With the years end approaching, now is a good time to review financial goals and asset allocation. Definitely, lightning impacted stocks negatively this decade, but betting for lightning to strike in the next decade too could very well turn out to be a losing wager.

The US stock market was the world leader in the great bull market of the late 1990s. But more recently, it has been a laggard, in large part because of the weakness of the dollar. A stock investor looking for a part of the world to invest in back in 1998and to hold onto until nowcould not have done worse than to choose the US.

Consider the movements of both the S&P 500 and the S&P International 700 in the period since the American index first reached 1,100 on March 24, 1998. The International 700, which encompasses the non-American stocks in the S&P Global 1,200, rose much faster in the middle of this decade, then fell faster in the global recession. But since prices bottomed, it has leaped more than 80%.

For the entire period, an investor was better off in emerging markets than in the developed world. Segments of the global index representing Latin America, Australia and emerging Asian countries have soared. The Canadian index also more than doubled, thanks largely to natural resources stocks. But prices, as measured in local currencies, are lower now than in 1998 for both the S&P Europe 350 and the S&P/Topix 150, covering Japan. Measured in American dollars, those markets posted gains of 20% and 7%, respectively, because of currency movements.

On a sector basis, the best place to be over that period, both in the US and globally, was in energy stocks. Oil prices fell to just above $10 a barrel in late 1998, and few investors saw value in the area. More recently, oil company profits set records as crude soared well above $100 a barrel, and even after the global downturn the price is more than $70. Financial stocks have suffered more in the US than in the rest of the world, but the credit crisis brought down many banks in other regions as well.

Also consider 15 well-known companies from around the globe whose share prices are at least 300% higher than they were in 1998, and 15 such companies whose prices are less than half what they were then. Such a list shows that performances can vary wildly within an industry. While British Airways and All Nippon Airways make the losers list, Ryanair of Ireland was a big winner. Fiat and Ford were losers, while Hyundai shares leaped. Makers of communication equipment include Research in Motion, the producer of BlackBerry phones, which is up more than 8,000%, and Alcatel-Lucent, which is down almost 90%.

As the next decade loomsits only a few days awayone big question is whether it will be as bad for US stocks as the previous one. A person investing money in the S&P 500 in December 1999, and hoping to use the stock market returns to retire next month, would now have less money in his pocket. Putting money into US Treasury debt would have been a better option. Buying government bonds is supposed to be risk-free. By comparing these two assets, investors can assess the returns from risk taking.

Equities vs Treasuries

Well, risk has not paid off. Taking the annualised return on the S&P 500 and subtracting the rate paid on Treasury bills, there have been no benefits to taking equity risk. Indeed, there has been a negative annualised reward of minus 3.4% in the past decade.

A terrible decade for stocks is rare, but it is not unprecedented. There have been three other decades in the last century where equities have failed to deliver returns and Treasuries have done better: the 10 years leading to 1939 (minus 5.7%), 1974 (minus 4.8%) and 1982 (minus 3.6%).

Interestingly, the next 10 years were great for stocks. After 1939, the S&P returns in the next decade were 9.2%, after 1974 stocks notched up 15.6% and after 1982 the gains were 19.2%.

This will not necessarily be repeated. But there is some logic to it. After a decade of price falls, the cost of entering the market is less. Whether it is low enough relative to alternatives depends on risk appetite. But the only explanation for a repeat of the past decade for US stocks would be if Japanese-style deflation took hold.

The author is a Wharton Business School MBA and CEO, Global Money Investor