Say Goodbye to the Lost Decade

Back in 2008 and 2009, many investors bemoaned the poor performance in stocks over the preceding 10 years, often referring to it as the "Lost Decade." Yet now, you may soon find that like the revisionist Ministry of Truth in George Orwell's 1984, one of the most challenging periods in stock market history will start disappearing from performance records.

The danger of trailing returns
Experienced investors have seen endless reminders that they shouldn't rely on past performance as indicative of future results. Yet it's almost impossible not to focus on past performance as a factor in evaluating a potential investment.

But the lesson that investors absolutely have to learn is that they need to keep their own memories, because the market does its best to wash away past events, leading to untrustworthy conclusions about long-term performance.

Where we've been
Three years ago, I took a look at whether another lost decade was approaching for the stock market. In it, I noted that investors were more pessimistic than ever at prospects for the markets, given that the S&P 500 had fallen by about 2.5% annually on average during the preceding 10 years. Moreover, a number of stocks, including Gap (NYSE: GPS  ) , Microsoft (Nasdaq: MSFT  ) , and Intel (Nasdaq: INTC  ) , had posted even weaker 10-year returns.

Now, though, when you make a 10-year appraisal of those figures, they look very different. Microsoft and Intel are up an average of 4% and 5% per year, respectively, over the past decade, while Gap weighs in with a whopping 13% average annual return.

Of course, there are two aspects to those performance gains. The market's big gains since 2009 have been truly extraordinary. For its part, Gap has almost doubled in the past three years, with all of those gains coming in 2012 as the company benefited from the warm winter and a rare success with its fashion lines this year. Similarly, Intel has risen about 50% in the past three years in a move consistent with the overall market, and Microsoft has gained 40% as it has worked to shore up its core software business and expand in productive ways.

Wiping out the losses
A huge part of the turnaround in apparent performance, though, comes from taking the tech-bust years of 2000 through 2002 out of the equation. As Fool UK's Harvey Jones noted last week, return comparisons involving tech stocks in particular have benefited from the change in the comparison baseline, as 1999 and 2000 stock prices were much higher for both Intel and Microsoft, among many others, than they were by 2002.

But the effect certainly isn't limited to tech stocks. The S&P 500 has gone from its loss to an apparent 6% annual gain over the past 10 years, solely due to changing start and end points. Even the Dow Jones Industrials (INDEX: ^DJI  ) look a lot better with 2002 as a starting date than 1999 or 2000.

In fact, pretty much the only stocks that don't behave like this were those rare companies that actually gained ground during the tech bust. For instance, for Altria (NYSE: MO  ) , the Lost Decade never looked particularly lost, as the company posted huge gains throughout the period. After hitting lows near the turn of the millennium on concerns about potential legal liability that threatened to bankrupt the entire industry, Altria ended up getting off much more lightly than many had feared, and its shares soared even during 2001's recession.

Don't get surprised
Back in 2009, I advised investors not to put too much weight in weak 10-year returns, because their starting point wasn't representative of a sustainable market environment. The same is true three years later, except with the opposite conclusion: Using comparisons based on the absolute market bottom in 2002 will almost certainly give you results that are far more optimistic than is warranted.

So as you start hearing mutual funds and other money managers tout 10-year performance, take it with a grain of salt. When you look at both today's great past results and the weak ones of the Lost Decade, the truth lies somewhere in between.

Microsoft and Intel have both emerged stronger from the tech bust of 10 years ago, but they also face challenges. Get the low down on the pros and cons of both of these stocks by reading through our top tech analysts' thoughts on Microsoft and Intel here.

Fool contributor Dan Caplinger read 1984 in 1984. He doesn't own shares of the companies mentioned in this article. You can follow him on Twitter @DanCaplinger. The Motley Fool owns shares of Microsoft and Intel. Motley Fool newsletter services have recommended buying shares of Microsoft and Intel, as well as creating a synthetic covered call position in Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy never says goodbye.

Read/Post Comments (5) | Recommend This Article (17)

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 August 23, 2012, at 10:28 AM, Njja wrote:

    More drivable, no talk about the economy, unemployment, or the current lack of experience or leadership from the white house. Just more self serving nonsense using the past to explain an enlightened point of view.

  • Report this Comment On August 23, 2012, at 1:28 PM, TENOFWANDS wrote:

    This kind of feel-good MELIORISTIC GIBBERISH is at the root of our FAILURE at the crucially necessary recognition of FUNDAMENTAL FLAWS in our system of commerce. What is wrong with our prevailing economic policies will LOSE US MORE THAN A MERE DECADE.

  • Report this Comment On August 23, 2012, at 6:12 PM, xetn wrote:

    Just watch what happens to the economy when on Jan. 1, the largest tax increases in history slaps the economy into the toilet.

  • Report this Comment On August 24, 2012, at 2:06 PM, lowmaple wrote:

    xetn So you are buying Puts to take advantage of that drop?

  • Report this Comment On August 27, 2012, at 12:10 AM, 2motley4words wrote:

    Wow, every previous commenter seems to have overlooked (or ignored?) the fact that, rather than addressing the economy, unemployment, or some alleged "fundamental flaws in our system of commerce," the author's clear purpose was (1) to state the fact that trailing 10-year returns will vary widely, depending on the starting point that one chooses, and then, on the basis of that fact, (2) to suggest that investors take any trailing 10-year period's returns with a large grain of salt (i.e., that past returns are no guarantee of future results).

    Shame on you, Dan, for daring to write about a topic other that which some of your readers want to rant about.

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