The Worst Decade for Stocks ... Ever

According to data compiled by Yale finance professor William Goetzmann, U.S. stocks will very likely close out the worst calendar decade in recorded history this month (Goetzmann's data goes back to the 1820s). That's a harsh lesson for buy-and-hold investors: Yes, stocks are very often an attractive asset class, but not always ... and certainly not at any price. But what of the next 10 years?

First, the gruesome context:

Decade

Annualized Nominal Return (incl. dividends)

Annualized After-Inflation Return (incl. dividends)

2000s*

 (1%)

(3.4%)

1990s

18.2%

14.8%

*To Dec. 21, 2009.
Source: Author's calculation based on data from Standard & Poor's and the Bureau of Labor Statistics.

It was the best of times, it was the worst of times
This decade's horrendous performance follows one of the best calendar decades for stocks. In the 1990s, stocks roared ahead (of themselves), boosted by the Internet revolution and a favorable economic environment. This succession of near best and worst decades is no coincidence -- it's an illustration of Jeremy Grantham's observation that "mean reversion is a reality"; i.e., periods characterized by above-average historical returns are generally followed by periods of below-average historical returns.

Valuation: a sorcerer's apprentice
The reason for these swings in performance? Valuation, largely. Stocks got a huge boost from multiple expansion in the 1990s; according to data compiled by Yale finance professor Robert Shiller, the cyclically adjusted price-to-earnings ratio rose from 17.65 in December 1989 (a bit above the historical average) to 44.2 in December 1999 -- an all-time high. (The cyclically adjusted P/E multiple is based on average earnings over the prior 10-year period). That multiple could not defy gravity eternally; odds were good that stock returns over the next 10 years would be disappointing.

And that's exactly what came to pass. Not surprisingly, among the bottom 5% of S&P 500 stocks in terms of performance during this decade, technology and financials are the best represented sectors, while the top 5% is heavy with energy companies:

Company

Annualized 10-Year Return (incl. dividends) to Dec. 21, 2009

S&P 500 Top 5% Performers*

 

XTO Energy (NYSE: XTO  )

52.3%

Southwestern Energy (NYSE: SWN  )

50.5%

Denbury Resources (NYSE: DNR  )

30%

S&P 500 Bottom 5% Performers*

 

Citigroup (NYSE: C  )

(19.7%)

Akamai Technologies (Nasdaq: AKAM  )

(22.6%)

E*Trade Financial (Nasdaq: ETFC  )

(23.7%)

Sun Microsystems (Nasdaq: JAVA  )

(24.5%)

*Selection.
Source: Author's calculations based on data from Capital IQ, a division of Standard & Poor's.

What's in store for investors next?
Surely after a period of such miserable returns, we can now look forward to great returns over the next 10 years? Unfortunately not -- unless you're betting on another massive stock market bubble. If we should have learned anything from the past 10 years, it is that valuation matters. At yesterday's closing price, the S&P 500 is valued at 20.3 times cyclically adjusted earnings -- nearly 25% above its long-term historical average multiple. Asset manager GMO's latest return forecasts, produced at the end of November, have large-cap and small-cap U.S. stocks earning less than 4.5% on an annualized basis over the next seven years. Index investors should be underweight U.S. stocks right now -- international equities are an attractive alternative.

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Alex Dumortier is on Twitter, but he has no beneficial interest in any of the companies mentioned in this article. Akamai Technologies is a Motley Fool Rule Breakers pick. The Fool owns shares of XTO Energy. Try any of our Foolish newsletters today, free for 30 days. Motley Fool has a disclosure policy.


Read/Post Comments (27) | Recommend This Article (46)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 23, 2009, at 4:35 PM, rsinsheimer wrote:

    "At yesterday's closing price, the S&P 500 is valued at 20.3 times cyclically adjusted earnings -- nearly 25% above its long-term historical average multiple."

    This is only meaningful if you believe that corporate earnings will not improve in the future. Given the fact that we're clawing our way out of the second-ugliest recession of the last 100 years (if you see The Depression as a single recession, as opposed to multiple ones back-to-back, as some do), it's not unreasonable to think that in the reasonably near future companies will be seeing increased earnings. This will consequently drive the P/E down to reasonable values, more in line with historical averages.

    In other words, at this point in the bust/boom cycle, it is reasonable and normal for the market P/E to appear to get ahead of itself.

  • Report this Comment On December 23, 2009, at 4:42 PM, starbucks4ever wrote:

    This article is another example of following the latest hot trend.

  • Report this Comment On December 23, 2009, at 4:47 PM, Varchild2008 wrote:

    S&P today is not like S&P of yesterday.....

    Some stocks got kicked out of the S&P.... And some stocks got put in, in their place.

    So how do you evaluate the S&P of today versus some historic average when the companies that make up the S&P are not the ones from the 1990s?

  • Report this Comment On December 23, 2009, at 5:24 PM, TMFAleph1 wrote:

    @rsinsheimer,

    "This is only meaningful if you believe that corporate earnings will not improve in the future."

    Thanks for your interest. Your criticism would be applicable if I were using a P/E multiple based on trailing 12- month earnings. However, the cyclically-adjusted P/E (CAPE) multiple is based on average real earnings over the prior ten-year period. Because the CAPE is conceived to smooth out the distortions introduced by earnings volatility, no such criticism can be made in this case.

    If you would like a more detailed explanation of this point, see pages 13-17 (and specifically, the discussion of 'Test 5') in the following paper: 'Stock Marker Valuations' by Andrew Smithers/ Stephen Wright ( http://www.rh.edu/~stodder/SmithersWright.pdf ).

    For a yet more detailed discussion, I highly recommend 'Valuing Wall Street' (2000) by the same authors.

    @Varchild2008,

    "So how do you evaluate the S&P of today versus some historic average when the companies that make up the S&P are not the ones from the 1990s?"

    The fact that the S&P 500 isn't a static set of companies doesn't invalidate the comparison. Despite changes in the index, the CAPE has proved to be one of the only useful valuation measures in terms of identifying periods of over- and undervaluation. For evidence of this, see the references I mention above in my response to rsinsheimer.

    Best,

    Alex Dumortier, CFA

  • Report this Comment On December 23, 2009, at 5:49 PM, kelbon wrote:

    This article is more than loosely based on an article "Investors Hope the '10s Beat the '00s" by Tom Lauricella published in the Wall Street Journal on Monday, December 23, 2009. Both articles reference William Goetzmann, Jeremy Grantham, and Robert Shiller.

  • Report this Comment On December 23, 2009, at 5:49 PM, bzjc7g wrote:

    We a re only finishing the ninth year of the 21st century. The first decade would end at the end of 2010.

  • Report this Comment On December 23, 2009, at 6:14 PM, royvb wrote:

    To bzjc7g - Wrong. every 10 years is a decade. The one being referred to is the first decade of the current century, That century began on 1/1/2000 - and ends ten year later - i.e. 12/31/2009. It includes years ending 12/31/00, 01, 02, 03, 04, 05 06, 07, 08, and 09 - or ten years in all

  • Report this Comment On December 23, 2009, at 6:30 PM, TMFAleph1 wrote:

    @kelbon,

    The article isn't "more than loosely based" on the WSJ article you mention, but it was inspired by it -- specifically by the mention of Goetzmann's finding that the 00s are likely to be the worst calendar decade for U.S. stocks in recorded history. This is the only fact that I sourced directly from the WSJ article. Both tables contain data that I calculated myself based on primary data, for example.

    Furthermore, I've used a similar framework in numerous articles on the level of of stock market valuation over the past six months.

    Finally, if you take a look at my articles relating to this topic*, you'll find that I frequently refer to the cyclically-adjusted P/E ratio (sometimes referred to as Shiller's P/E), Robert Shiller and Jeremy Grantham -- much more frequently that Mr. Lauricella or any other reporter/ commentator at the Wall Street Journal, in fact.

    Best,

    Alex Dumortier, CFA

    * You can find these articles here: http://www.fool.com/feeds/AuthorHeadlines.aspx?author=1475&a...

  • Report this Comment On December 23, 2009, at 6:54 PM, TMFAleph1 wrote:

    @zloj,

    Thanks for your interest. You wrote:

    "This article is another example of following the latest hot trend."

    Which "latest hot trend" are you referring to? I wouldn't qualify international stocks, which I mention favorably in the final paragraph that way.

    If anything, with the S&P 500 up 65% with respect to its March 9 low, it seems to me that the "following the latest hot trend" consists in paying an above-average multiple for U.S. stocks at a time when the economy remains extraordinarily fragile, with many potential speed bumps on the horizon.

    Best,

    Alex Dumortier

  • Report this Comment On December 23, 2009, at 7:11 PM, Zinj wrote:

    It has already been mentioned, but it bears repeating - the first CALENDAR decade of this millennium

  • Report this Comment On December 23, 2009, at 7:14 PM, Zinj wrote:

    Again, the first CALENDAR decade of this millennium ends Dec 31, 2010.

    There was no year zero. So the first day of the first year is understood to be Jan 1, year 1, the first year doesnt END until Dec 31 year 1. The tenth year ends Dec 31 year 10. Count that forward to the present day.

    This fact was mentioned extensively in the press around the year 2000 celebrations (hint: third millennium AD began 1/1/2001, not 1/1/2000). Even Seinfeld parodied this misunderstanding. But here we are again professing ignorance about our own date system. I wonder if the Aztec calendar has this issue....

  • Report this Comment On December 23, 2009, at 7:18 PM, Zinj wrote:

    hadn't seen royvb's post. Royvb, you're wrong on this one because of the (annoying) fact that our date system doesn't have a year zero. See my previous post.

    Now if we DROP the whole "calendar" part of "calendar decade", then yes, the decade can be any 10 year period of time, say April 16 2004 through April 15, 2014. But the first sentence of the article says "calendar decade", so it's wrong. That calendar decade doesn't end until Dec 31, 2010.

  • Report this Comment On December 23, 2009, at 7:21 PM, Zinj wrote:

    PS I also get annoyed about the "10 items or less" signs at grocery stores....proper grammar would be "10 items or fewer", but that's a happy rant for another day. ;-)

  • Report this Comment On December 23, 2009, at 7:27 PM, TopAustrianFool wrote:

    Non-sense. That assumes that you invested in 2000 and held, without adding to any positions. So the "worst decade ever" needs a huge qualifier. If you kept buying regularly it means it is probably the best decade aver to have bought stocks. As a scientist it doesn't surprise me that this type of research is coming out of Yale. How can this be the worst decade ever under those terms, if the 30's and 40's were a complete waste when it comes to earnings? If you buy this you'll believe anything.

  • Report this Comment On December 23, 2009, at 7:30 PM, TopAustrianFool wrote:

    Qualifiers. Need qualifiers please. What does the headline means?

  • Report this Comment On December 23, 2009, at 7:54 PM, starbucks4ever wrote:

    Outperformance of international equities vs. US was a trend of the last decade. Those who sell S&P 500 to purchase the BRIC bubble are like generals who prepare for the last war.

  • Report this Comment On December 23, 2009, at 8:10 PM, pkluck wrote:

    s0jrtorr makes a good point, I continued to buy during the decade and I'm up a fair amount.

  • Report this Comment On December 23, 2009, at 8:55 PM, TMFAleph1 wrote:

    @zloj,

    If you reduce "international" to the BRICs countries, then this hot trend has blunted your perspective. There are other markets beyond the U.S. and the BRICs!

    Personally, I agree that one should be extremely cautious in respect to the China story.

    Alex Dumortier

  • Report this Comment On December 23, 2009, at 8:59 PM, TMFAleph1 wrote:

    @s0jrtorr,

    As you can imagine, it's difficult to include numerous qualifying clauses in a title. This is daily web-based commentary, not a submission to an academic colloquium.

    What is it about the title that you don't understand?

    Alex Dumortier

  • Report this Comment On December 23, 2009, at 10:14 PM, starbucks4ever wrote:

    "If you reduce "international" to the BRICs countries, then this hot trend has blunted your perspective. There are other markets beyond the U.S. and the BRICs!"

    But what else if not BRIC? Japan's govt is going bankrupt, and Europe offers a 50% currency downside. Israel would be a good bet, but it too is now overpriced...

  • Report this Comment On December 24, 2009, at 10:48 AM, Fool wrote:

    Shouldn't interest rates relative to p/e multiples be considered? That is the lower the interest rate on say the 10 or 30 year Tbond the higher expected p/e multiple. If that is the case then the current multiple relative to interest rates is perhaps low.

  • Report this Comment On December 24, 2009, at 3:23 PM, goalie37 wrote:

    Using calendar dates to measure stock performance is too arbitrary to be trusted. The worst decades must be looked at in the context of what was going on at the time. The January 1st 1930 was a date coming a few months after the crash. December 31st 1939 was during a bull run up in advance of World War II. Like wise, January 1st 2000 was near the high of a bubble and December 31st 2009 was in the aftermath of a crash. These factors would make the 2000s look worse than the 1930. The old saying that numbers don't lie is wrong. Numbers can be manipulated to show whatever point you want to make.

  • Report this Comment On December 25, 2009, at 7:19 PM, Gorm wrote:

    While I realize this is a "global economy" the US has been the world's key consumer!

    This recovery looks nothing like the past recoveries, which often reflected overextended consumers, a spike in funding costs, etc.

    Unemployment is not only high but duration is setting records. Atop the credit over-extension, consumers are suffering negative home equity, decreased job opportunities, investments down, all levels of government reflecting HUGE funding problems, etc. I suspect consumers going forward will be more frugal, worried of the risks that face them, to include a falling standard of living.

    Believing deflation the greater risk, I don't see corporations on the eve of a recovery, a surge in earnings!!

  • Report this Comment On December 26, 2009, at 10:30 AM, Rich9988 wrote:

    Enjoyed this article and it does seem to have some reasonable empirical data and analysis behind it. I definitely get the impression there is a lot of cash still around ready to pile into pretty much anything (like anyone with some savings, I have that problem). So a word of caution is welcome.

  • Report this Comment On December 28, 2009, at 11:23 AM, Fool wrote:

    The ticker for Southwestern Energy is SWN.

  • Report this Comment On December 31, 2009, at 2:31 PM, steveballmer wrote:

    MSFT (1%)

  • Report this Comment On January 04, 2010, at 4:22 PM, carjjc wrote:

    It is not suprizing that the past 10 years were so poor. Or political leaders set poor policies that cost companies profit potential. This is a good example that a tax break and a war are not always good.

    jc

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