A Lost & New Decade, Part I

January 29, 2010

The last decade was tough, and the next one may not be much rosier. Where should you look for strength today?


At the past decade’s end, the
equity market (Standard & Poor’s® 500 Index) experienced its first lost decade (negative returns with dividends) since the 1930s. Prior to reducing returns for the erosion in value caused by inflation, the S&P 500 lost -9.1 percent (0.95 percent yearly) and -4.6 (0.51 percent yearly) during the 2000s and 1930s, respectively. Returns were worse after inflation (in real terms) during the last decade: Stocks lost -29 percent, which compounded at -3.4 percent annually. Deflation lifted real performance to 16.7 percent (1.55 percent yearly) in the 1930s. Stocks were also better values during the 1930s, primarily because they offered a 4.9 percent average dividend yield compared with the paltry 1.8 percent paid during the 2000s.

Both periods suffered aggregate corporate earnings declines, near -47 percent and -65 percent, resulting in yearly earnings declines of -6.1 percent and -9.9 percent, respectively. The more severe collapse in earnings during the 2000s as a whole resulted in an 8 percent S&P price-to-earnings ratio (P/E Chg) expansion compared with a 0.9 percent expansion during the 1930s. Figure 1 displays decade-by-decade components of returns.


A Lost New Decade Part I Fig1


Gold, Commodities And Bonds Ruled In The 2000s

Figure 2 charts the performance of the major asset classes that hedge inflation and deflation (default risk) best. During the last decade, the major diversifiers (the majors) provided the following annual compound total returns:
spot gold futures 14.1 percent (gold); commodities, 7.1 percent (Dow Jones UBS Commodity Index, DJ-UBS TR); Treasury notes, 5.4 percent (Notes); and domestic stocks -0.95 percent (S&P with dividends, SPX w/ Divs).

The majors were compared with the U.S. dollar performance, which declined 2.6 percent yearly. Other widely employed asset classes offered positive returns net of inflation, with the exception of foreign equities and direct real estate investment, which returned 1.9 percent yearly and -2.7 percent yearly, respectively. Direct real estate investment lost in nominal and in real terms. The best yearly compound returns were had by emerging market stocks at 7.3 percent, real estate stocks at 6.8 percent, domestic bonds (government/corporate) at 6.4 percent, Treasury inflation protected bonds (TIPS) at 5.6 percent, U.S. small company stocks at 3.5 percent and 3-month T-bills at 3.0 percent.

London bullion bested gold spot futures with an annualized return of 15.6 percent. I employ U.S. gold nearby futures prices because
futures market data also help me to measure the strength and weakness of price trends. Investors also have to pay storage and tax costs for holding gold, so the lower
U.S. spot price nets out closer to a domestic investor’s returns.

The inflation rate was 2.7 percent during the 2000s. The decade’s economic growth was 2.7 percent and 3.2 percent for real gross national product (RGNP) and real gross domestic product (RGDP) respectively. RGNP measures our nation’s economy net of domestic foreign investment, which correlates better with asset class performance. RGDP excludes foreign investment data. Consequently, I focus more on RGNP than RGDP when researching asset class returns.


A Lost New Decade Part I Fig2



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