November 2008
Matt McGrath, CFP®
Principal
Chief Planning Officer/Wealth Manager
(305) 448-8882 ext: 206
MatthewMcGrath@EvenskyKatz.com
The Lost Decade
As our clients know by now, financial planning is the cornerstone of our investment management. We begin every engagement with a new client by modeling, based on our clients’ goals and unique circumstances, the feasibility of achieving these goals relative to their resources. That plan serves as a basis for the investment recommendations and is regularly updated to ensure we are always looking forward, taking new information into account as it becomes available.
A look at what the stock markets have done over the last ten years demonstrates why it is so crucial to have a plan. The ten year total return of the S&P 500 through the end of October 2008 was a paltry 3.9%. That’s total return, not annualized. Most people would consider ten years a fairly long time horizon. To earn practically nothing in the stock markets over a ten year horizon is a difficult concept to digest. However, having a plan in place and continually updating it along the way allows for small changes to accommodate the volatility of the markets. Investing without a plan, though, would make that Lost Decade a disaster. Like it or not, investing does involve a little luck. The pattern and timing of market returns is simply unknown. No one plans to retire at a market bottom. Good planning, however, at least considers such an occurrence and evaluates its potential consequences.
That being said, many people may still wonder if the markets have ever been through such an awful spell and, if so, what came next? Now this is in no way meant to suggest that what has happened in the past is going to happen again in the future. We all know the, “past performance is no guarantee of future performance” disclaimer. However, sometimes it is helpful to put the current environment into context by having a better understanding of market history.
Admittedly, what follows is merely historical data obtained by looking in our rear view mirrors. It does not tell us when the current bear market will turn around or how bad it might get before it does. It does show us, though, that we have been through scary times before and eventually things did get better.
Through October 31, 2008 the S&P 500 is down 32.8% year-to-date. With two months still remaining in the year, that number could change quite dramatically; but if it did not move at all, it would come in as the third worst year since 1926. Only 1931, at -43.3% and 1937, at -35.0% fared worse. So what happened next?
In 1932 the market fell another 8.2%. Investors must have been quite discouraged. However, the five year period beginning in 1932 resulted in annual returns averaging 22.5%. Even handicapped by the poor start, investors were suddenly and unexpectedly rewarded for their patience.
Following the 35% loss in 1937, the market shot up 31.1% in 1938. Investors were likely a little more optimistic now. However, the five year period beginning in 1938 turned in average returns of only 4.6% despite the stellar start. The obvious point is that we have no way of knowing what will come next. The more important point is that in order to recover market losses you need to stay invested in the market because the upside could (and generally does) come when you least expect it.
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Not surprisingly, the worst decade for the stock market was the 1930s. The Great Depression took its toll on the economy and the markets. The total return of the market during the 1930s was -1.0%. Inflation during that decade actually annualized at -2.0% so investors did earn a small real return, but one might call that a moral victory at best.
The decade beginning January 1, 2000 will not conclude until the end of 2009. Through October 31, 2008, though, the market is down 23.1%, or -2.9% annually. In fact, the return in the equity market will have to exceed 28.7% between now and the end of 2009 in order to avoid becoming the worst decade on record. I am not about to predict if that will happen or not, but it certainly emphasizes how poorly the market has performed since the bull run ended in the late 1990s.
As an aside – many people have started to predict we are entering another Great Depression. While technically anything is possible, it is important to recognize how different things really are now. In the Great Depression unemployment skyrocketed to levels exceeding 20%. We are currently hovering around 6.5% with many experts projecting a rise to something between 7.5% and 9%. In the Great Depression people literally lost their money in bank accounts overnight. Today, bank accounts are backed by the government. There are plenty of things to be concerned about in the current economic environment, but it is important to keep them in perspective as well.
Framing the worst decade – the 1930s – consider the decades that followed. The 1940s saw average annual market returns of 9.2% while the 1950s saw average annual returns of 19.4%. Imagine what an investor in 1939 might have been thinking after finding their stock market investment worth less than it was ten years earlier. Could they really have expected their portfolio to increase by almost 150% over the next ten years and by almost 1300% over the next twenty years?
In more recent history, the market generated an average annual return of only 1.2% from 1965 to 1974. What came next? Investors realized average annual returns of 14.8% from 1975 to 1984. How many people, after suffering through a ten-year period ending in 1974, do you think were really expecting a great run the next ten years? The political and economic environment in the early 1970s was not exactly inspiring optimism. In fact, many of the headlines in the 1970s could be substituted in today’s papers and no one would know the difference.
Again, I do not intend to suggest we are on the cusp of such stratospheric returns. But I am
suggesting it is practically impossible to predict exactly when the difficult times will end and when prosperity will begin again. If anyone could really do that with any accuracy you would already know their name by now because they would be very rich and very famous.
Even though the 2000s are not quite over yet, we are sitting in our own Lost Decade. From November 1998 to October 2008 the market has provided an average annual return of 0.4%. Investors are frustrated looking back over the last ten years and thinking about how much better off they would have been in bonds, CDs, or even money market. We know hindsight is always 20/20, but that does not necessarily make us feel any better.
Assuming the world economy does recover (for what it’s worth – our Investment Committee believes it will) the markets will turn around eventually. I have tried to highlight some of the previous Lost Decades to help put our current Lost Decade into perspective. More importantly, remember that having an Investment Policy grounded in a sound financial plan can help mitigate the effects of a Lost Decade on your long term financial goals. Investing without a plan is kind of like driving without a map or street signs. You’ll end up somewhere, but is it where you want to go?
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