The media calls 2000 to 2009 the “lost decade”. In many ways it was. The S&P 500 index sits nearly 25% below its December 31, 1999 level. Add back dividends and you’ve still seen an 8% loss for the last 10 years. Yet, inflation has not stopped; you’ll pay $1 for what you could have bought for 75 cents back then.
There had never been a decade where the stock market’s total return left you with less than you started with, not even the 1930s or the 1970s. What makes it even crueler was equities were coming off two of the best decades ever, with the S&P advancing more than 400% on a total return basis in each of the 1980s and the 1990s.
While looking in the rear view mirror is not a recommended investing approach, here are seven key lessons from the last decade.
1. Avoid The Market’s Hottest Sectors
At the decade’s start it was all about technology and telecom. Clicks, eyeballs, bits, bytes, and miles and miles of fiber optic technology seemed to promise a new era, and investors were eager to cash in. Yet, valuations always matter, so despite some stunning technology advances over the next 10 years, these sectors handed investors their biggest losses, with the returns on technology and telecom stocks down 48% and 53% respectively over the period.
What would have happened if you invested in what appeared to be the new century’s most outdated sector, with seemingly little growth potential? Call it the revenge of the smokestack economy: energy stocks trumped all other sectors rising 144% and materials stocks came in second, advancing 54%.
As you prepare for the next decade, be cautious about jumping on the current bandwagons, and consider what might surprise investors the most. Gold and emerging markets seem to be the market favorites today, while the financials are the whipping boys.
2. Expect The Unexpected
No one could have predicted the turbulence of the last decade: 9/11, the worst financial crisis since the 1930s, the bankruptcy of our largest automaker and insurance company, unemployment topping 10%, the scandals of Tyco, Enron, and WorldCom, the collapse of residential real estate, wars in Iraq and Afghanistan.
Conversely, what we were worrying about a decade ago was the freeze up of our computers as we hit Y2K. Indeed, airlines suspended flights over that New Year’s. Books were being written about Dow 36K, strategists proclaimed a new era for tech stocks, and stocks were said to be far less risky than previously thought if held over the long term. None of that came true.
The takeaway is you can predict all you want, but rest assured that the big problems and opportunities of the coming decade are not now contemplated. Prepare, don’t predict, to weather the unimagined over the next ten years.
3. Diversify Your Assets
While investors over the past decade lost on average 1% per year in the broad stock market, if they had employed a 60/40 blend of stocks and government bonds, their return would have averaged 3.1% per year. A 40/60 blend would have garnered a 5% return. If a 60/40 investor had gone a step further and diversified one third of his equity money into international stocks he would have further improved his returns, averaging 3.7% annually. A regular commitment to rebalancing, meaning buying more of the underweighted asset if price changes have skewed your portfolio from the target, would have further improved returns; you would have bought stocks in the 2002-3 downturn and lightened up as the market hit its all time high in 2007.
Your takeaway is that you can reduce the risk of being invested in the worst performing asset class by diversifying over several asset classes. Another important lesson is that you cannot assume that stocks, or for that matter any asset class, will be the best (or worst) performing asset class over the next ten years. Finally, the mechanical discipline of rebalancing regularly into your worst performing asset class will further enhance your odds.
4. The Next Decade Will Be Better
While investors are understandably disappointed with the returns from the 21st century’s first decade, there is good reason to believe that the next decade will be better. This is not the time to throw in the towel.
Valuations are much better. The aggregate value of the S&P 500 is just $10.1 trillion, while it was $12.3 trillion ten years ago. Further, after adjusting for inflation, it’s just 75% of that $10.1 trillion, or only $7.5 trillion in year 2000 dollars. So, you are paying today a lot less for America’s 500 most prominent companies, while at the same time alternatives like bonds offer much less competition due to their low interest rates.
Historically, investment returns are cyclical; there is a tendency for returns to revert to the mean. The average annual return on the S&P 500 is about 10%, so at some point history suggests that returns going forward will outpace the negative annual returns of the past decade. There have never been back to back decades of negative price returns on the S&P.
The takeaway is that investors should be far more comfortable investing in stocks today, given lower valuations following a dismal 10 years; they should have been far more cautious a decade ago, following 20 years of outsized returns and stretched valuations.
5. Be Skeptical of the Smart Money
While it always pays to be humble in investment matters, it does not follow that the “heavy hitters” have special insight or should be blindly followed. A particularly instructive example is AOL. At the start of the decade AOL, under Steve Case’s leadership, paid nearly $100 billion to acquire the biggest media company of the day, Time Warner. By 2003, Steve Case had left the combined company. By the end of this year Time Warner will have distributed its interest in AOL to shareholders following dismal performance and a massive destructive of shareholder value. Newcomers to the Internet space like Google completely changed the landscape.
Investors will find similar cautionary tales when tracing the history of such one time moguls as Sandy Weill at Citigroup and Maurice Greenberg at American International Group. The last decade also saw its share of just plain crooks in corporate America, including Bernie Ebbers at Worldcom, Kenneth Lay at Enron, and Dennis Kozlowski at Tyco.
Commit now as we enter a new decade to avoid investments designed to mimic the moves of the “bold face” prominent names.
6. Fundamentals Matter, But Don’t Overpay
Cisco Systems came into the decade trading at nearly $54 per share, the largest company in the S&P 500. Since then its earnings per share have compounded 13% annually, it’s remained free from scandal, and is considered a leader in Internet technology. Yet, today the stock is at less than $24 per share. Investors have received no dividends. How could this happen?
The simple answer is that investors were paying 100 times earnings back then, a price that discounted years if not decades of future earnings. Your takeaway is you must avoid even great companies if the price is, well, too pricey.
Can a mediocre growth situation at a great price produce superior results? Yes. Philip Morris was marked down to $5.32 per share at the decade’s start, out of fear of crippling litigation and high taxes. Those concerns still lurk, and of course the number of smokers continues to decline. Earnings per share have fallen 3.9% annually over the decade. Yet, with the stock now over $19 per share, investors have scored a 16.3% average annual return over the decade, if you include all dividends plus the shares of Kraft and its overseas operations distributed during the period.
7. Beware Mindless Investing “Truths”
Stocks are less risky than bonds if held for the long term. Residential real estate will never go down nationwide. A better understanding of our economy and more tools of monetary and fiscal policy at our disposal will free us from the financial crises of the past.
In fact, in the decade just past bonds walloped stocks, returning nearly 8% per year versus the negative 1% on the S&P. Residential real estate dropped across the country by nearly a third from its peak in 2006. The collapse of key financial institutions like AIG, government sponsored mortgage lenders Fannie Mae and Freddie Mac, and Lehman and Bear Stearns precipitated a run on money market funds; our economy nearly ground to a halt.
To handle the inevitable surprises of the next ten years, investors must prepare, not just predict. Avoid concentrated positions in any one stock or asset class. Consider constantly how changes in the economic outlook and the tax and legislative framework could affect your portfolio, and how you could hedge the risks.
David G. Dietze
Point View Financial Services, Inc.
www.ptview.com
There had never been a decade where the stock market’s total return left you with less than you started with, not even the 1930s or the 1970s. What makes it even crueler was equities were coming off two of the best decades ever, with the S&P advancing more than 400% on a total return basis in each of the 1980s and the 1990s.
While looking in the rear view mirror is not a recommended investing approach, here are seven key lessons from the last decade.
1. Avoid The Market’s Hottest Sectors
At the decade’s start it was all about technology and telecom. Clicks, eyeballs, bits, bytes, and miles and miles of fiber optic technology seemed to promise a new era, and investors were eager to cash in. Yet, valuations always matter, so despite some stunning technology advances over the next 10 years, these sectors handed investors their biggest losses, with the returns on technology and telecom stocks down 48% and 53% respectively over the period.
What would have happened if you invested in what appeared to be the new century’s most outdated sector, with seemingly little growth potential? Call it the revenge of the smokestack economy: energy stocks trumped all other sectors rising 144% and materials stocks came in second, advancing 54%.
As you prepare for the next decade, be cautious about jumping on the current bandwagons, and consider what might surprise investors the most. Gold and emerging markets seem to be the market favorites today, while the financials are the whipping boys.
2. Expect The Unexpected
No one could have predicted the turbulence of the last decade: 9/11, the worst financial crisis since the 1930s, the bankruptcy of our largest automaker and insurance company, unemployment topping 10%, the scandals of Tyco, Enron, and WorldCom, the collapse of residential real estate, wars in Iraq and Afghanistan.
Conversely, what we were worrying about a decade ago was the freeze up of our computers as we hit Y2K. Indeed, airlines suspended flights over that New Year’s. Books were being written about Dow 36K, strategists proclaimed a new era for tech stocks, and stocks were said to be far less risky than previously thought if held over the long term. None of that came true.
The takeaway is you can predict all you want, but rest assured that the big problems and opportunities of the coming decade are not now contemplated. Prepare, don’t predict, to weather the unimagined over the next ten years.
3. Diversify Your Assets
While investors over the past decade lost on average 1% per year in the broad stock market, if they had employed a 60/40 blend of stocks and government bonds, their return would have averaged 3.1% per year. A 40/60 blend would have garnered a 5% return. If a 60/40 investor had gone a step further and diversified one third of his equity money into international stocks he would have further improved his returns, averaging 3.7% annually. A regular commitment to rebalancing, meaning buying more of the underweighted asset if price changes have skewed your portfolio from the target, would have further improved returns; you would have bought stocks in the 2002-3 downturn and lightened up as the market hit its all time high in 2007.
Your takeaway is that you can reduce the risk of being invested in the worst performing asset class by diversifying over several asset classes. Another important lesson is that you cannot assume that stocks, or for that matter any asset class, will be the best (or worst) performing asset class over the next ten years. Finally, the mechanical discipline of rebalancing regularly into your worst performing asset class will further enhance your odds.
4. The Next Decade Will Be Better
While investors are understandably disappointed with the returns from the 21st century’s first decade, there is good reason to believe that the next decade will be better. This is not the time to throw in the towel.
Valuations are much better. The aggregate value of the S&P 500 is just $10.1 trillion, while it was $12.3 trillion ten years ago. Further, after adjusting for inflation, it’s just 75% of that $10.1 trillion, or only $7.5 trillion in year 2000 dollars. So, you are paying today a lot less for America’s 500 most prominent companies, while at the same time alternatives like bonds offer much less competition due to their low interest rates.
Historically, investment returns are cyclical; there is a tendency for returns to revert to the mean. The average annual return on the S&P 500 is about 10%, so at some point history suggests that returns going forward will outpace the negative annual returns of the past decade. There have never been back to back decades of negative price returns on the S&P.
The takeaway is that investors should be far more comfortable investing in stocks today, given lower valuations following a dismal 10 years; they should have been far more cautious a decade ago, following 20 years of outsized returns and stretched valuations.
5. Be Skeptical of the Smart Money
While it always pays to be humble in investment matters, it does not follow that the “heavy hitters” have special insight or should be blindly followed. A particularly instructive example is AOL. At the start of the decade AOL, under Steve Case’s leadership, paid nearly $100 billion to acquire the biggest media company of the day, Time Warner. By 2003, Steve Case had left the combined company. By the end of this year Time Warner will have distributed its interest in AOL to shareholders following dismal performance and a massive destructive of shareholder value. Newcomers to the Internet space like Google completely changed the landscape.
Investors will find similar cautionary tales when tracing the history of such one time moguls as Sandy Weill at Citigroup and Maurice Greenberg at American International Group. The last decade also saw its share of just plain crooks in corporate America, including Bernie Ebbers at Worldcom, Kenneth Lay at Enron, and Dennis Kozlowski at Tyco.
Commit now as we enter a new decade to avoid investments designed to mimic the moves of the “bold face” prominent names.
6. Fundamentals Matter, But Don’t Overpay
Cisco Systems came into the decade trading at nearly $54 per share, the largest company in the S&P 500. Since then its earnings per share have compounded 13% annually, it’s remained free from scandal, and is considered a leader in Internet technology. Yet, today the stock is at less than $24 per share. Investors have received no dividends. How could this happen?
The simple answer is that investors were paying 100 times earnings back then, a price that discounted years if not decades of future earnings. Your takeaway is you must avoid even great companies if the price is, well, too pricey.
Can a mediocre growth situation at a great price produce superior results? Yes. Philip Morris was marked down to $5.32 per share at the decade’s start, out of fear of crippling litigation and high taxes. Those concerns still lurk, and of course the number of smokers continues to decline. Earnings per share have fallen 3.9% annually over the decade. Yet, with the stock now over $19 per share, investors have scored a 16.3% average annual return over the decade, if you include all dividends plus the shares of Kraft and its overseas operations distributed during the period.
7. Beware Mindless Investing “Truths”
Stocks are less risky than bonds if held for the long term. Residential real estate will never go down nationwide. A better understanding of our economy and more tools of monetary and fiscal policy at our disposal will free us from the financial crises of the past.
In fact, in the decade just past bonds walloped stocks, returning nearly 8% per year versus the negative 1% on the S&P. Residential real estate dropped across the country by nearly a third from its peak in 2006. The collapse of key financial institutions like AIG, government sponsored mortgage lenders Fannie Mae and Freddie Mac, and Lehman and Bear Stearns precipitated a run on money market funds; our economy nearly ground to a halt.
To handle the inevitable surprises of the next ten years, investors must prepare, not just predict. Avoid concentrated positions in any one stock or asset class. Consider constantly how changes in the economic outlook and the tax and legislative framework could affect your portfolio, and how you could hedge the risks.
David G. Dietze
Point View Financial Services, Inc.
www.ptview.com
