Can the Lost Decade Strike Twice?

December 23, 2009 at 1:45 am 10 comments

There is an old saying that lightning does not strike twice in the same place. I firmly believe this principle will apply to stock returns over the next decade. Josh Brown, investor and writer for The Reformed Broker highlighted a chart published by Bloomberg showing the 10-year return for various asset classes. Statisticians and market commentators have been quick to point out that stocks, as measured by various benchmarks, have not only underperformed bonds for the last 10 years, but stock performance has actually also been negative for the trailing decade.

Source: Bloomberg via The Reformed Broker

Will this trend persist during the next decade? Will the lost decade in stocks be repeated again, similar to the deflation death spiral experienced by the Japanese? (Read more regarding Japanese market on IC).  With the Fed Funds rate at effectively zero, is it possible bonds can pull off a miracle over the next 10 years? I suppose anything is possible, but I seriously doubt it.

Let’s not forget that the P/E ratio (Price-Earnings) pegged by some to be at about 14-15x’s 2010 expected earnings – nestled comfortably within historical bands. Granted, financials and some other sectors were overheated (e.g. certain Consumer industries), but based on next year’s estimates, some industries are already expected to exceed the peak earnings achieved during 2007 (e.g., Technology).

History on Our Side

Source: Crestmont Research. Dated graph over the last century showing stock returns rarely result in negative returns over a rolling 10 year period.

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. This chart gets chopped off in 2005, nonetheless history is on our side, lending support that stock returns have a good chance of improving on the results over the last 10 years.

Equity Risk Premium

The bubbles and scandals that have blanketed corporate America over the last 10 years have made the average investor extremely skeptical. 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 endeavor, 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 desire – lots of skepticism and money piled into bonds (See IC article on investor queasiness). 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 analysis above is obviously very narrow in scope, since we are only discussing domestic stock markets. In my client portfolios 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 year-end fast approaching, now is a good time to review your financial goals and asset allocation.

Lightning definitely negatively impacted stocks this decade, but betting for lightning to strike twice this decade could very well turn out to be a losing wager.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at time of publishing had no direct positions in BRKA. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

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Entry filed under: Asset Allocation, Financial Markets, Fixed Income (Bonds), Stocks, Themes - Trends. Tags: , , , , , , .

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10 Comments Add your own

  • 1. Getting off the Market Timing Treadmill « Investing Caffeine  |  February 21, 2010 at 11:32 pm

    [...] effectively no results.  Most media outlets continue to focus on the “lost decade” (see other Lost Decade story) in which investors have earned nothing in the equity markets. After a decade of excess in [...]

    Reply
  • [...] Doomsayers think the market is valued at crazy levels, and believe that “buy-and-hold” investing is dead. Bears remind investors that stocks have led to nothing good except for a lost decade of performance (read article on Lost Decade). [...]

    Reply
  • [...] I certainly don’t mean to demonize John Mauldin because his writings are indeed very thoughtful, interesting and include provocative financial topics. But put in the wrong hands, his opinions (and dozens of other strategists’ views) can be extremely dangerous for the average investor trying to follow the ever-changing judgments of so-called expert strategists. To Mauldin’s credit, his writings are archived publicly for everyone to sift through – unfortunately the media and many average investors have short memories and do not take the time to hold strategists accountable for their false predictions. Although, Iike Warren Buffett, I do not make market timing predictions or forecast short-term market trends, I see no problem in strategists making bold or inaccurate forecasts, as long as they are held responsible. Every investor makes mistakes, unfortunately, strategist predictions are usually not readily available for analysis, unlike tangible investment manager performance numbers.  When forecasting lightning strikes and extreme bets win, every newspaper, radio show, and media outlet has no problem of placing these soothsayers on a pedestal.  Thanks to the law of large numbers and the constantly shifting markets, there will always be a few outliers making correct calls on bold predictions. Who knows, maybe Mauldin will be the next CNBC guru du jour in the future for predicting another lost decade of equity market performance (see Lost Decade article)? [...]

    Reply
  • [...] lot of compounding of returns has occurred in the domestic equity markets over the last decade (see Lost Decade), but that weakness is not necessarily representative of the next decade’s performance or [...]

    Reply
  • [...] Can the Lost Decade Strike Twice?  [...]

    Reply
  • [...] as measured by the S&P 500 index, has done absolutely nothing over the last 12 years (see Lost Decade). Over the last 10 years, the market is actually down about -20% without dividends (and about flat [...]

    Reply
  • 7. momomiester  |  June 21, 2010 at 8:28 am

    The lost decade has to do with the gutting of manufacturing with this so called “free trade” . Market isn’t going anyway due to the average American isn’t going anywhere. Take out the real estate bubble and the laying of debt what have we done for the last 10yrs? All we did was let China manipulate their economy to take market share all the while we borrow money from them. Nothing will change till we deal with this problem.

    Reply
  • [...] the midst of the so-called “Lost Decade,” pundits continue to talk about the death of “buy and hold” (B&H) investing. I guess it [...]

    Reply
  • 9. Is Buy and Hold Investing Dead? | Wall St. Cheat Sheet  |  September 28, 2010 at 8:59 am

    [...] the midst of the so-called “Lost Decade,” pundits continue to talk about the death of “buy and hold” (B&H) investing. I guess it [...]

    Reply
  • 10. QE2 Drowning TIPS Yields Below Water « Investing Caffeine  |  October 26, 2010 at 10:55 pm

    [...] Sluggish Economy: Lackluster growth and fear of double dips have pressured rates lower as debates still linger  about whether or not the U.S. will follow Japan (see Lost Decade). [...]

    Reply

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