The Global Stock Market Funk: U.S. Stocks' 'Lost Decade'

 The Global Stock Market Funk: U.S. Stocks' 'Lost Decade'

Fellow Investor,

The headline on the front page of last Wednesday's Wall Street Journal confirmed many U.S. investors' suspicions: the U.S. stock market has been a tough place to make money during the last decade. With the S&P 500-stock index closing at 1322.70 yesterday, it now is trading below the 1362.80 it hit in April 1999. The Dow is slightly better off -- having risen about 1% a year since January 2000. For the past nine years, the S&P 500 is the worst-performing among nine different asset classes, including commodities, real-estate investment trusts, gold and foreign stocks. Even low-risk Treasury bonds have outperformed U.S. stocks. Once you adjust for inflation, there is little doubt that investors in the U.S. stock market have lost money in real terms. And with the relentless decline of the U.S. dollar during the past five years, foreign investors in U.S. stocks have fared substantially worse.

The Global Stock Market Funk: Conventional Wisdom Questioned

It wasn't supposed to be like this. The belief that buying a broad range of stocks and holding them generates better returns than any other class of assets is financial religion among U.S. investors. After all, historically, U.S. stocks have risen about two years out of every three, for an average real return of about 7%. And according to Ned Davis Research, stocks have shown gains for almost every 10-year period since 1925 -- 98.6% of the time. Today's investors, it seems, have been simply unlucky.

Academics who have parsed the historical performance of U.S. stocks going back into the 19th century note that U.S. stocks underperformed other investments during both the 1930s and the 1970s. They've also uncovered a pattern. It's the decades that follow the ones in which stock investing becomes a mania -- as in the 1920s, the 1960s and the 1990s -- that stocks tend to underperform. Boom is followed by bust and stock returns “revert to the mean." The road to 7% annual real returns is a bumpy one.

The good news is that if the historical pattern continues to hold, then the upcoming decade should be stronger for U.S. stocks. Yale economist Robert Shiller is more pessimistic. He thinks the U.S. market still has tough years ahead of it. Shiller, the author of “Irrational Exuberance," expects the housing bust to impair consumer spending in the United States for many years, as people pay off debt and rebuild their savings. And since 70% of the U.S. economy is driven by consumption, a tapped out U.S. consumer means lower economic growth and lower profits.

The Global Stock Market Funk: U.S. Stocks #1?

Yet the recent performance of global stock markets presents a paradox. On the one hand, the United States is ground zero of the current global financial crisis. On the other, the U.S. stock market has held up better than almost any developed market in the world. The S&P may be down 11% this year. But Germany, France and Japan have dropped about twice as much. And last year's much heralded economic titans have suffered even more: India is down almost 20%, and China has fallen by about a third. That's a big change, as foreign shares have trounced U.S. stocks every year since 2002.

Look past the doom and gloom, and U.S. stocks have a couple of things going for them. First, U.S. multinationals are raking in profits as never before. Profits earned in euro or yen inflate profits in dollar terms. Conversely, the weak dollar acts as a drag on the profits of European and Japanese giants. A stronger euro or yen makes it harder for global exporters to compete with their U.S. rivals.

Second, last year’s top performing global markets were due for some kind of correction. With the Chinese stock market doubling last year, and India up 47%, a correction was inevitable -- as it always is with the benefit of 20/20 hindsight. But even relatively inexpensive global markets are swept up in today's negative sentiment. Both Russia and Brazil are relatively inexpensive, have huge foreign reserves, and are generating money hand over fist thanks to the commodities boom. Yet even their stock markets are down.

 The Global Stock Market Funk: Investors Aren't Standing Still

Investors are hardly ignoring the global stock market funk. Worldwide, they pulled close to $100 billion out of equity funds in the first three months of this year. More than half of the 25-largest mutual fund firms in the United States had outflows in the first two months of this year. Contrast that with the height of the dotcom boom in 2000 -- and the very peak of the market -- when Americans alone invested $260 billion into U.S.-stock mutual funds. By 2007, these same investors took $46.4 billion out of the market.

So where are U.S. investors putting their money? They are opting for a combination of money market funds, riskier foreign markets and specialized products like hedge funds. Money market funds attracted $140 billion in the first quarter alone, more than what was taken out of stock markets. Commodity funds attracted $3 billion, triple the rate of last year. Specialized funds focusing on the Middle East and Africa and Russia attracted the most money among foreign stocks.

That said, the numbers presented in the Wall Street Journal study may make things look worse than they really are. Just about a decade ago, the United States was in the grip of a technology stock market bubble, with valuations at eye-popping levels. The S&P 500 almost halved in the subsequent crash. But if you look back only five years, say, starting in early 2003, the U.S. market actually doubled from trough to peak. Some global markets more than quadrupled. And as someone who looks at front page stories in major publications as contrarian indicators, I think it's exactly when “there is blood in the streets" that it's the time to buy. And with both retail investors and fund managers sitting on a record pile of cash, there is plenty of cash to fuel that fire once sentiment turns.

Sincerely,