Wednesday, March 26, 2008

WSJ: Stocks Tarnished by Lost Decade

This is something I've touched about in the past on the blog - how anyone investing in general indexes since Jan 1, 2000 is underwater. One thing I definitely agree with Jim Cramer on is there "is always a bull market" somewhere, so you can always make money on something, but it takes a lot of hard work, thinking, and interest in the markets. For the great many who live normal lives and investing is simply something they do through most large cap mutual funds (many of which are simply S&P 500 clones disguised to rake in large fees) in their regular accounts or 401ks, it's been a tough decade. And that's not adjusted for inflation in which real returns are clearly negative. Last, that's in dollar terms; the story has been a disaster for foreign investors who have had to put up with the dollar decimation to boot (on top of inflation adjusted real returns). So while the stock market does well over "long periods" of times, I'd consider a decade to be a serious amount of time - and this has been a bad decade. Unless you had the stomach (following huge losses in 2001/2002) or simply had good timing to start following the stock market in 2003, there has simply been no easy way to make money using traditional indexes. And NASDAQ investors? Still down in a big way.

This is why the Pollyanish "everything will be fine" in the long run attitude about the US continues to worry me. Stocks were not necessarily overpriced a decade ago - but we created a bubble - and the aftershocks of said bubble still reverberate all these years later. And without that bubble (spike) in 99/00 where have we gone? If stock prices are a reflection of the underlying health of the economy (through corporations)? And going forward what are the catalysts to get out of this funk? That's the bigger question for me at this point - almost everything in the US is based on a financial or consumerism model. And the financials are now going through a NASDAQ type correction that frankly, I believe will be very similar to the tech bubble - yes there will be large spikes off of oversold bottoms but risk aversion should stick around at least for another 2-4 years and almost all these financials goosed earnings by taking outsized risks and then leveraging to a massive degree. That era is now gone (until a new round of suckers is born in 5-6 years), and some parts of their revenue stream will disappear. [Mar 20: Citigroup Warns: the "Great Unwind" Has Begun] So those that assume that "after the correction" financials will just go right back to where they were in 2005-2006, I'd point to a very similar situation as the tech stocks earlier in the decade - unsustained valuations caused by irrational behavior and easy credit; and the stocks are still nowhere near where they "were". While we are going back to the easy credit era (one new bubble solves an old seems to be the logic), the risk aversion will take quite a while to work through. So that leaves consumerism as the remaining driver. I guess we can continue spending individually again until we go blue in the face - but again, access to credit is not going to be quite so easy so even people who want to do this will have a harder time AND I belive the lessons learned (the hard way) by many individuals will chastise them into perhaps saving "a little" go forward.

And then the wildcard is inflation - just how bad will it get and how sustained over the next 3-10 years? If it remains elevated (which I believe it will), then you have a permanent dent in consumer buying culture and by proxy our consumerism culture. So what is the next great driver? It appears green energy but frankly a few European countries/Japan have a huge lead time on us. Our top leadership, in some circles, is still denying Global Warming at this stage so how do you become a leader in green energy under that backdrop? So as I try to weigh things in the "long run" I am trying to think what will be the next driver of the US "service" economy to jump start the economy and the markets for a sustained period of time (5-10 years). All I can think of (aside from commodities that we do have) is some unknown technological break throughs in clean energy or simply a return to the home flipping game (creating fake paper wealth) in 3-4 years. So I wonder if the stock market performance the past decade has really signaled a lot of the economic power lost slowly but surely by "the masses" - which most US focused companies do cater to (as the wealth becomes concentrated in multi nationals and the top 2%). But hopefully something surprises me in the future; but until then I continue to focus overseas where the real future growth appears to be. I continue to go that route because when I think of macro economic trends and rank countries who will benefit from what I believe is happening globally, it is hard to place the US even in the top 5 anymore. I am mulling if we have another lost decade coming in front of us - don't think it can happen? Japan has been in bear market since 1989. We are NOT Japan, but we do have some of the same bubbles/mistakes (easy money, low interest rates, housing bubble, etc). While we used to allow creative destruction in the past 3-6 months we've seemed to have shifted to a more socialistic model where losses are socialized... sort of what we criticized Japan for doing. And our structural deficits will eat our entire GDP by 2030? Not exactly a path for prosperity.... people will need to pay higher taxes and/or take on more of their own costs for "needed things" - leaving less money for consumerism. Again, all paths seem to lead to the same direction ... unfortunately.

  • Over the past 200 years, the stock market's steady upward march occasionally has been disrupted for long stretches, most recently during the Great Depression and the inflation-plagued 1970s. The current market turmoil suggests that we may be in another lost decade.
  • The stock market is trading right where it was nine years ago. Stocks, long touted as the best investment for the long term, have been one of the worst investments over the nine-year period, trounced even by lowly Treasury bonds.
  • The Standard & Poor's 500-stock index, the basis for about half of the $1 trillion invested in U.S. index funds, finished at 1352.99 on Tuesday, below the 1362.80 it hit in April 1999. When dividends and inflation are factored into returns, the S&P 500 has risen an average of just 1.3% a year over the past 10 years, well below the historical norm, according to Morningstar Inc. For the past nine years, it has fallen 0.37% a year, and for the past eight, it is off 1.4% a year.
  • Conventional stock-market wisdom holds that if investors buy a broad range of stocks and hold them, they will do better than they would in other investments. But that rule hasn't held up for stocks bought in the late 1990s or 2000.
  • Over the past nine years, the S&P 500 is the worst-performing of nine different investment vehicles tracked by Morningstar, including commodities, real-estate investment trusts, gold and foreign stocks. Big U.S. stocks were outrun even by Treasury bonds, which historically perform much less well than stocks. Adjusted for inflation, Treasurys are up 4.7% a year over the past nine years, and up 5.8% a year since the March 2000 stock peak. An index of commodities has shown about twice the annual gains of bonds, as have real-estate investment trusts.
  • Stocks also underperformed other investments during the 1930s and the 1970s. During both of those periods, stocks would rally strongly, only to fade.
  • But Yale economist Robert Shiller, who predicted the market trouble in his 2000 book "Irrational Exuberance," warns that the market still hasn't shaken off its excesses. He and some other analysts think the latest volatility is a symptom of more trouble to come. "I have to say that this isn't a great time to be in the stock market," says Prof. Shiller. "The housing crisis that we are going through is going to put a damper on the economy that is longer than a recession. I don't see the stock troubles ending as quickly as many people are imagining."
  • "When you have extraordinary returns, as we did from 1982 through 1999, then usually the next 10 years aren't very good," says Prof. Sylla. His research suggests that exceptional booms steal gains from the future. When the booms end, returns become subpar, so that average returns over the longer term fall back to the 7% norm. Economists call this "reversion to the mean," the idea that exceptional performance can't last forever. (keep in mind the 7% normal, in a highly inflationary environment that our Federal Reserve has helped bestowed upon us means much less than in a low inflation environment)
  • In recent years, investors have been putting far less money into U.S. stocks than they did during the stock-investing boom. In 2000, at the height of that boom, Americans added $260 billion to U.S.-stock mutual funds, according to the Investment Company Institute, a trade group. Last year, investors took more money out of those funds than they put in -- a net outflow of $46.4 billion.
  • A big problem for the market right now is what analysts call stock fundamentals. Strong corporate-profit gains and low inflation have supported stocks since 2002, but they are becoming harder to sustain. In a typical year, Prof. Sylla says, corporate profits run at about 5% or 6% of total economic output, after tax. In 2006, that number was 9%, a record. Historically, this number tends to revert to the mean, suggesting that profits now could weaken. "Profits may fall to 3% or 4%" of economic output, Prof. Sylla says.
  • Spending by ordinary people could have an effect on those profits. Consumer borrowing and spending kept the economy afloat after the stock bubble popped in 2000. Emboldened by high home values, people borrowed at levels rarely seen, pushing down the national savings rate to zero.
  • A consumer pullback would hold back economic growth and corporate profits, putting a damper on U.S. stock gains and giving investors an incentive to continue putting money into commodities or stocks in Brazil, Russia, India and China. Baby boomers concerned about retirement income could look for safer investments with guaranteed returns, such as Treasury bonds and bond-like products offered by mutual-fund companies.
  • "We have to accept that this is no longer a nation of 4% real economic growth. This is a mature nation that no longer has a strong manufacturing base," says Steve Leuthold, chairman of Leuthold Weeden Research in Minneapolis. (Bingo)
  • "The S&P 500 never got back down to its long-term trend line" after the 1990s, says Jeremy Grantham of Boston money-management firm Grantham, Mayo, Van Otterloo & Co. Mr. Grantham, who has long warned of a prolonged period of subpar stock performance, says exceptionally low interest rates temporarily propped up the indexes. (Bingo, as I keep saying, easy credit will inflate all assets - but once again 8% stock return in a 9% inflationary environment means you lose - you just don't realize it)
  • There are reasons to hope that things won't be as ugly this time as they were either in the 1970s or in the 1990s in Japan, which went into a prolonged slump after bubbles in its housing and stock markets. For one thing, although inflation has been running above 4% this year, it remains well below the double-digit rates of the 1970s. That's made it easier for the Fed to stimulate the economy without worrying about sparking runaway inflation. (lies, lies, and more lies: 4%? No, it's 13% - 4% is if you believe the government statistics)

Disclaimer: The opinions listed on this blog are for educational purpose only. You should do your own research before making any decisions.
This blog, its affiliates, partners or authors are not responsible or liable for any misstatements and/or losses you might sustain from the content provided.

Copyright @2012