Higher.
Let’s start with a historical look at ten year stock market cycles. The chart below starts (see 1) in December 1937 when the US stock market (excluding dividends) was down 40% over a full 10 year period. Though the stock market was extremely volatile (a 20% decline followed the 40% ten year collapse, then a 50% rally, and a subsequent 40% decline – see Note).
A massive post WWII boom was experienced in America in the 1950s and 1960s, but the major stock market gains were investors who “entered the market” in the late 40s, and enjoyed the cumulative 10 year return of 300% (see 2). Markets moved gradually higher during the 1960s, and in the 70s suffered a major inflationary headwind and in real terms were down over 70%. In nominal terms, by the late 70s stock investors had suffered a 10 year cumulative return of roughly 0% (similar to today?, see 3).
Thus began the glory days of corporate America and the global financial system. Stock investors were handsomely rewarded for entering the stock market in the early 80s. To give you an idea, the S&P was trading at 111 in March 1982, and by March 2000 was trading at 1,500. The bulk of this gain was concentrated in the tech bubble of the late 90s, but still this was an amazing period for equity investors, with only one negative calendar year in 17 years on a total return basis! As such investors were handsomely rewarded with a cumulative 10 year return of nearly 350% through the end of the decade (see 4).
Now begins the dreary 2000s which had its own boom- bust cycle. The current 10 year return (through October 2010) is currently -17%.
What is most interesting is that the historical average of a 10 year investment in US stocks (excluding dividends) is capital appreciation of 107%.
This reminds us of some important lessons of investment management:
- That no matter how euphoric or demoralizing financial price trends may seem, at some point, conditions change and the markets establish a new trend.
- It is extremely difficult to time a market top or bottom
- Markets often correct through the mean (as you can see by the average 10 year return)
Our take from the above is that it is easy to project that the upcoming years will have very low returns: there is a historical precedent (negative annualized returns for the past decade), fundamental reasons (risk free rate near 0%, difficult earnings environment, etc), demographic reasons (the huge portion of Americans set to retire in the upcoming 10 years that will not stomach the volatility of Equities and prefer to have stable Fixed Income investments), etc. But looking at the historical cycle tells us that experience would beg to differ. What is clear is that after abnormally high (low) returns, one should never lose sight that stock market assets in a healthy economy will likely produce returns far below (above) the mean. What’s more, taking a lesson from Prospect Theory, we should note that humans are fallible. As markets move for an extended period in one direction, investors will overestimate the likelihood that markets will continue in the same direction.
So, what would be a new direction? Above average returns. Let’s hope.
Note that in June 1937 Roosevelt’s administration took drastic steps in an ill fated attempt to balance the federal budget. The S&P fell 20% through March 1938. It rallied 50% through the end of 1938, and then fell again another 40% through 1942. This was of course due to the effects of America’s war time economy subsequent to the Pearl Harbor attack and Eisenhower beginning a massive front in Europe.
