The “Lost Decade” is becoming an oft-used label for the past ten years and deservedly so.  Following the substantial declines in market averages since October 2007, many are now in negative territory for the past decade (on an annualized basis).  The following chart, courtesy of Capital Guardian, plots the 10-year annualized returns of U.S. equities going back to the early 1800s.  The current reading (-1.5%) is comparable to only one other instance, the 10-year period ending 1937 (The Great Depression).

Source: Capital Guardian

What will the next ten years bring?  No one has a crystal ball to help forecast future returns.  Looking at history, however, gives us a precedent and a guide to what we might expect.  Following previous “lost decades”, equity returns have typically rebounded with double-digit annualized returns over the subsequent ten years.  (Returns during the decade following 1937 fell just short of double digits as this period encompassed WWII.)

Source: Capital Guardian

If one were to base investment decisions only on the past 10 years, it would certainly be easy to conclude that equities have not produced adequate returns.  However, equities have delivered a 9% annualized return over the past 80 years, a period that incorporates the Great Depression, WWII, the lost decade of the 1970s, the TMT bubble bust, and the bear market of 2008.  Few investors have such a long time horizon, but the long-term average is helpful in framing expectations and putting bull and bear markets in perspective.  Cycles in investing are inevitable; the long-term trend-line, however, slopes upward, rewarding patient and disciplined investors with ample reward for the risk taken.

We closed the books on 2008 with a rally, but it did little to repair the damage of the severe bear market that commenced in October 2007.  U.S. equities were not alone in their misery; in fact, they outperformed most other developed and emerging markets during 2008.  The following table shows returns for major stock markets around the world since their respective highs, for calendar 2008, and since the November 21st lows.

Source: Prieur du Plessis “Investment Postcards from Cape Town”

The New Year ushered in new hopes and old worries.  The 44th President was sworn into office in front of two million people lining the National Mall on a cold day in Washington.  He promptly got to work on a pressing agenda as soon as the last inaugural ball ended.  The challenges he and his administration are facing are very serious.  Economic indicators have continued to paint a gloomy picture, supporting expectations of significant contractions in GDP in 4Q08 and 1Q09.  Manufacturing production in 4Q08 declined 10% YOY; holiday sales plunged 3.4%, the series’ first decline since comparable data began in 1993; job losses continue to pile up month after month, pushing the unemployment rate to 7.2%.  Not surprisingly, consumer confidence hit a new low in December.  This certainly does not bode well for consumer spending – the largest contributor to U.S. gross domestic product – in the coming months.

Furthermore, financial markets have continued their volatile ways.  At the January 22nd close, the S&P 500 Index level of 827 was 8% below the year-end close of 903, but still 10% above the November 20th close of 752 and 12% above the intra-day low of 741 established on November 21st.  Beacon Pointe has stated in past letters that re-testing of the lows is normal when markets are in a bottoming process.  We continue to believe that this is the case.  Whether the November 2008 lows hold or are broken, we expect market action to remain volatile as hope and fear tug investor sentiment in opposite directions.

Most recently, the epicenter of investor concerns has shifted back to the financial sector.  A new wave of warning signs from struggling Bank of America, Citigroup, and State Street Corporation, among others, has served as a reminder that the sector is facing severe balance sheet challenges and will likely need additional and aggressive support from the government.  As a result, the financial sector is by far the worst performing sector in the S&P 500 Index for the YTD period, falling over 30% (through January 22nd, 2009).  Most of the leading financial institutions, both in the U.S. and abroad, have seen their market capitalizations shrink to a mere fraction of their former glory.

The Oracle of Omaha, in an interview with Tom Brokaw for NBC News, likened the current state of affairs to an economic Pearl Harbor.  People are fearful and confused, almost paralyzed.  It may look like we are losing, Mr. Buffett said, but “now we are going to get mobilized to win the war, which we will”.  He believes that the fiscal stimulus plan proposed by the new administration will serve as much-needed medicine for the ailing U.S. economy.  It may take a while for this medicine and other corrective measures to take effect, but they should eventually succeed in breaking the negative feedback cycle.  Mr. Buffett acknowledged that the current crisis is the worst faced by the U.S. since WWII, but “since 1776 it’s never paid to bet against America”.  He is confident that the country will come through this, despite the bumpy ride.  Such a vote of confidence from someone of Mr. Buffett’s experience, repute, and wealth is reassuring.

Please feel free to call Beacon Pointe at 949-718-1600 should you need additional information or have any questions.

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