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The first decade of the twenty-first century was one of the worst in modern history for U.S. equity markets.
Princeton University Professor Paul Krugman, a Nobel Prize winning economist and New York Times columnist, who has become a perennial pessimist, summed up what many are thinking: “. . . from an economic point of view, I’d suggest that we call the decade past the Big Zero. It was a decade in which nothing good happened, and none of the optimistic things we were supposed to believe turned out to be true.” In conclusion, Krugman wrote “. . . let’s bid a not at all fond farewell to the Big Zero – the decade in which we achieved nothing and learned nothing.”
The overwhelming consensus among economists, market analysts, business journalists and academics appears to be that the next decade will be, like the decade past, an utter failure. Richard Tedlow, a professor of business administration at Harvard Business School, says, “It’s been a decade of delusion . . . In many ways, we’re worse off than the 1930s, we’ve created problems of moral hazard and we’re faced with an astounding public debt.”
The best summation of the collective conscious comes from Pacific Investment Management Company (PIMCO), the manager of the world’s largest bond fund, Total Return. In May 2009, PIMCO management issued its secular (or long-term) forecast for a “new normal.” PIMCO describes the “new normal” as an economy comprised of slow growth, increased regulation and a diminishing role for the U.S. in the global economy.
PIMCO is not alone. Many others are downright bearish about the U.S. economy and absolutely giddy about emerging markets like Brazil, Russia, India, and China. But could this be a rearview mirror phenomenon? After all, the Morgan Stanley Capital International (MSCI) Emerging Markets Index is up an average 11.38% per year over the 10 years ending December 31, 2009. This is not dissimilar to the 1990s, where the average annual return of the MSCI Emerging Markets Index was 11.05%.
But in the 1990’s, returns in the U.S. were actually better than those of the emerging markets. According to the book Triumph of the Optimists: 101 Years of Global Investment Returns, the U.S. stock market returned an average 14.4% each year from 1990 through 1999.
Perhaps this is why in 1999 and 2000 James K. Glassman and Kevin A. Hassett copyrighted the BusinessWeek bestselling book, Dow 36,000. On the book’s cover is a quote from Knight Kiplinger, the Editor in Chief of Kiplinger Publications, who wrote about the book: “Rock-solid investment advice . . . Long-term investors can place it on an alter next to the works of Benjamin Graham and Peter Lynch, as well as Warren Buffet’s annual homilies to his Berkshire Hathaway investors.”
Well then, the opinions of today certainly stand in stark contrast to those of ten years ago. The reason is simple: It is human nature to predict the future based on the recent past.
Ironically, one of the few people who predicted the malaise of the 2000s was someone who ardently believes you cannot time the market. John Bogle, the founder of the Vanguard Group and the creator of the $92 billion Vanguard 500 Index Fund, foretold in 2001 of a prolonged period of poor performance for domestic stocks on the heels of the extraordinary returns of the 1980s and 1990s. Such prognostications are pretty good for a guy who rejects the validity of market predictions.
Today, Bogle says, “The 1990s was the golden decade for stocks, the 2000s was the tin decade and the next 10 years will be the bronze decade . . . Stocks will rise 7 to 9 percent over the next 10 years, below the historical norm but better than the last 10.”
The “tin decade” posted an average annual decrease of 0.9% a year for the S&P 500, including dividends. This is the first negative return for a decade since modern stock market data began in 1927. Without dividends, the index lost 24% of its cumulative price value over the last ten years. This compares to a 42 percent cumulative price loss during the 1930s. But, during the ‘30s, the dividend yield was substantially higher, resulting in an annualized 1% per year positive total return throughout the Great Depression decade.
Since we know many of the risks that the world economy faces – high indebtedness among developed countries, political instability in emerging nations, terrorism, aging populations, high unemployment, weak banks, a Chinese real estate bubble and tapped-out consumers, to name a few – let us examine some of the positive aspects that nobody wants to openly discuss.
As we have examined in this essay, the simple idea that markets run in cycles of outperformance and underperformance is a powerful one. Over time, markets, specifically equity markets, have produced robust returns. The previously cited Triumph of the Optimists calculated the total return of U.S. stocks from 1900 through 2000, 101 years, at 9.9% on average each year.
Another positive force is worldwide population growth, which Switzerland-based UBS AG predicts will increase by 3 billion over the next three to four decades. Presently the world houses approximately 6.7 billion people. Population expansion is a reliable driver of economic advancement as additional people lead to expanded consumption.
Technological progress is another major force of economic breakthroughs. Make no mistake; there has been no slowdown in new discoveries. Our guess is that ten years from now we will all be amazed at where we stand.
Finally, at the most fundamental level, earnings drive stock prices. Over the last decade, many businesses got lazy because capital was easy to raise through newfangled debt instruments and lax lending standards. In order to raise new capital going forward, businesses will need to be friendlier to shareholders. This will mean running with greater efficiency, which will result in stronger earnings.
As we move into this new decade, remember what government regulators require in all investment disclosures, “Past Performance is No Guarantee of Future Results.”
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