GOODBYE AND good riddance. That's likely to be the reaction of most equity investors as they shut the door on the noughties, a calendar decade as dismal as any in stock-market history., writes PROINSIAS O'MAHONY
In the US, the S&P 500 lost a quarter of its value over the past 10 years. Even allowing for the reinvestment of dividends, investors were still left with a double-digit loss of -11 per cent. Things look much uglier again when inflation is taken into account: a loss of 3.3 per cent per year, according to the Wall Street Journal,citing data compiled by North Carolina State University finance professor Charles Jones.
That is the worst performance of the last century, trumping even the Depression-era 1930s. Then, equities fell by almost 40 per cent. However, those share-price falls occurred against a backdrop of deflation and substantial dividends, thereby allowing investors to eke out an annual gain of 1.8 per cent.
US investors were far from alone in their woes. British investors cheered as the FTSE 100 peaked at 6,930 in the dying days of 1999. Today, it’s hovering around the 5,300 level, or almost 25 per cent lower. European indices fared even worse, with the FTSE Eurofirst 300 losing roughly 35 per cent of its value over the past decade.
The Iseq, touching 5,000 at the dawn of the millennium, today hovers around 3,000. The fall is reminiscent of another bubble-driven index that eventually crashed: the technology-heavy Nasdaq, which ended the decade approximately 45 per cent lower.
Japanese equities, too, almost halved in value over the past decade and are now worth a mere quarter of their 1989 peak. Canada was the only G7 nation to record market gains over the past 10 years.
The past decade has been a poke in the eye for those espousing the “buy and hold” investment mantra. Between 1982 and 1999, US equities returned an incredible 18.7 per cent per annum, fostering a cult of equities that led many to assume that shares were a one-way bet.
Equity markets have more than halved not once but twice over the past decade, however, with shares first being ravaged by the dotcom-led crash between 2000 and 2002 and then again in 2008 to 2009, when the global financial crisis took valuations to levels not seen in two decades.
“Put bluntly, the past decade has provided investors with an object lesson on the critical importance of long-term valuation,” noted Barclay Capital’s Tim Bond recently.
Earlier this year, a Barclays report found that the overvaluation of equities between 1995 and 2008 was the most extreme in stock-market history. The same point was made a decade ago by Prof Robert Shiller, author of Irrational Exuberance.
Shiller warned that stocks were trading at 44 times long-term earnings, way above the historical average of 16 and much higher than the famously stratospheric valuations of 1929.
The same argument was hammered home by investing guru Jeremy Grantham, who predicted that stocks would lose an average of 2 per cent per year during the first 10 years of the century. Warren Buffett was another investing luminary to warn that substandard returns awaited investors.
The secular bull market of 1982 to 1999 was the biggest in stock-market history, with annual returns almost twice the long-term average. The FTSE’s meteoric rise – it increased sevenfold between 1984 and 1999 – was similarly unsustainable.
The underperformance of the noughties, as US strategist Barry Ritholtz put it, was “payback for the massive gains in the salad days” of old.
So what for the following decade? History offers some crumbs of comfort to beleaguered investors. There have never been two down decades in a row. After inflation, stocks typically return about 7 per cent per year but returns typically exceed that following the poorest decades – on average, annual returns of 11 per cent, according to Barclays.
However, research also shows that periods of overvaluation tend to be followed by periods of notable undervaluation, often lasting years.
Société Générale’s Albert Edwards has been making the bearish case for all of the past decade and he remains sceptical.
“After some 15 years of gross overvaluation, do we really believe that this valuation bear market that has been in place since 2000 will finish with equities looking cheap for only three months?” he asked in a recent research note.
Edwards is referring to the fact that, even after the brutal bear market of 2000 to 2002, stocks remained well above their long-term trend and the acceleration of share prices in the cyclical bull market that followed exacerbated this continuing overvaluation. Stocks finally dipped below what long-term investors usually regard as “fair value” near the end of 2008 but they did not stay there for long, sprinting higher last March after unprecedented global stimulus.
The same point is hammered home by Grantham and fellow value investors. Currently, cyclically adjusted price-earnings ratios (Cape) – generally regarded as the most historically reliable of valuation metrics – suggest that US stocks are overvalued by approximately 20 to 25 per cent.
This is nothing like the overvaluations of 10 years ago, of course, and investors are still expected to make real – that is, inflation-adjusted – returns in the coming years. However, returns should be approximately 20 to 25 per cent less than their long-term average over the following decade, Cape advocates argue. That may seem bizarre to investors, given the awfulness of the last decade. After all, the mean-reverting stock market has typically rewarded those who take the plunge after periods of substantial underperformance. It is not uncommon for secular bear markets to last 15 years or more, however, and 1999’s unprecedented valuations mean investors may need to remain patient as market excess is worn off definitively. So does another lost decade lie in store? No, if history and valuations are any guide. But does this mean there will be a new secular bull market, an above-average decade that will reward those poor souls bloodied by the past 10 years?
It doesn’t look like it.
