The Lost Decade: S&P Annual Return Just 2.5% Since 1998

Most investors use a microscope to analyze markets, when a telescope is of more use, and therefore completely miss the big picture. Over the last decade, equities have underperformed bonds by the biggest margin in 70 years. The S&P 500 10 year total return to end June 2008 was 32.1%,  while that from bonds (based on the Lehman LT Treasury index) was 86.8%. Not since the end of the Great Depression has there been such a stunning divergence. US real estate could slump another 20% and would still have comfortably outperformed equities over the decade, as would cash, and just about any overseas market, particularly in dollar terms.

US stocks have been a lousy investment for a very long time, and the chart below helps explain why.

Based on calculations by John Hussman, one of the few commentators I follow closely (along with the likes of Bill Gross at PIMCO and Jeremy Grantham at GMO), the S&P in the summer of 1998 was on a Price/Peak Earnings ratio of almost 30, an all time record. This calculation effectively cyclically adjusts earnings over their entire history, and is a clever warning flag; anything above 18 suggests a market that will generate poor returns. Even the trough in 2003 was struck at the highest valuation ever for a bear market low. Forget the subprime debacle and short term market noise; equities have been historically expensive and have been in a grinding bear market since 2000 (since when the S&P total return has been precisely zero).

The contrarian in me says it's time for some serious mean reversion, particularly as I believe a secular 25 year bull market in fixed income is now over. However, although the US stock market returned 10-11% per annum over the last century, averages can be dangerously misleading; we had three identifiable 35 year cycles, incorporating 17 years of 18%-20% average annual returns along with 18 years of 2%-4% average returns. We're now probably midway through a subpar cycle from 2000-2015 or so. Another way of looking at it is that returns were 'front loaded' during the huge bull market from 1983 to 2000. I suspect we're in for another decade of mediocre performance overall, making sector selection and market timing all the more important. The 'buy and hold' and 'level down on the dips' cliches spouted by investment professionals have proved a recipe for wealth destruction in recent years, and will continue to be so. It is still easy to make serious money if you're able to understand market psychology and periodically take advantage of extremes in sentiment. In between times, just stay liquid.

My short call on the bubble in commodities and related stocks since April and long healthcare/banks in recent weeks is a case in point, and both the short and long sides would have returned 25-30% (banks in the past week have actually had the biggest move of any sector since records began in 1989).

Before you reach for the microscope, take a panoramic view with that telescope...

Comments

[malach hamo...:]

s&p 500 on 1/19/1993 - day before clinton took office: 435.13
s&p 500 on 1/19/2001 - day before Bush II took office: 1,342.54
s&p 500 yesterday afternoon 1,252.54

the Bush administration has been a complete disaster for the investor class; while tax rates may be lower, the gains are fewer and further between.

I'd rather make a shitload of money and pay tax than make nothing

2008 Jul 25 07:53 AM

[Octogenarian:]

The Clinton S&P performance were bogus from cooked books like Worldcom and Enron, which fueled the dot-com/Y2K bubble by buying and selling to bogus subsidiaries etc. Even Greenspan couldn't stand the bogus economy and penned the infamous irrational exuberance market dictum.

2008 Jul 25 11:37 AM

[irondoor91:]

The Dow is worth less today in gold-adjusted terms than it was in 1928. The Dow is down over 70% in gold/commodity adjusted terms since the top in 2000. If you remained invested in the same asset allocation for the past 8 years, you have gone nowhere in nominal terms, but you can't buy crap with your money today. Try paying your property taxes, insurance, fuel, power, college tuition, etc, etc with the same dollars as you had in 2000.

With respect to income taxes, you pay based on your nominal income, not your inflation-adjusted income. The masses and the Democrats are interested only in your nominal income, and your capital losses in this market are not going to do you any good. All investors will be taxed at the highest possible marginal rates and I expect that Obama will somehow figure out how to extend the SS tax to dividends, interest, and cap gains.

How else can they pay for the coming $1 trillion housing bailout?

2008 Jul 25 11:54 AM

[sorgmot:]

Past, present, and future is shown in the P/E chart displayed above.

It points out that the USA is in the 1930' again with P/E's on common stocks declining to between 5 and 10 where they will stay for 20 years.

Yields are now rising and will rise for 20 more years on stocks and bonds and other assets like real estate causing their US $ prices to fall.

The US $ will fall against foreign currencies because investors will move to foreign stocks and bonds and real estate for better yields.

USA living standards will continue to decline.

Huge numbers of US companies will move out of the USA or fail.

2008 Jul 25 12:09 PM