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:


Annualized Nominal Return (incl. dividends)

Annualized After-Inflation Return (incl. dividends)







*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:


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

S&P 500 Top 5% Performers*


XTO Energy (NYSE: XTO)


Southwestern Energy (NYSE: SWN)


Denbury Resources (NYSE: DNR)


S&P 500 Bottom 5% Performers*


Citigroup (NYSE: C)


Akamai Technologies (Nasdaq: AKAM)


E*Trade Financial (Nasdaq: ETFC)


Sun Microsystems (Nasdaq: JAVA)


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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