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SKARBECK: Looking at stocks, 10 years at a time

January 9, 2010

For investors, 2009 capped not only a tumultuous year, but a jarring decade that saw two asset bubbles collapse.

Last year began with a gut-checking 25-percent plunge in the Standard & Poor’s 500 index to early-March lows, only to be followed by an astonishing 65-percent spike into the year’s end.

The overall result of this V-shaped market movement was a 26.5-percent return on the index (dividends reinvested) for 2009. Without question, it was a result that far surpassed anything investors might have imagined as the year began.

Yet the strong finish in 2009 was not enough to save stock returns over the past decade—a period that suffers from the drawback of starting at an overvalued market level.

If you recall, 10 years ago, investors were flooding the hot technology mutual funds with record cash inflows just two months before the market peaked in March 2000. As such, the return for the decade on the S&P 500 index was an aggregate loss of 9 percent, or just less than a loss of 1 percent annually.

During this century’s first decade, investors had to cope with the uncertainties surrounding 9/11; huge corporate failures including Enron, Worldcom, Fannie Mae, Freddie Mac, and Lehman Brothers; and volatility wrought by both the tech and housing bubbles.

And yet, sandwiched in between were four benign years, beginning with the Iraq War in March 2003 and lasting through spring 2007, when the market enjoyed an uninterrupted steady progression higher. The market nearly doubled during that stretch, and many investors were lulled by the absence of volatility, which left them unaware of the risks that had accumulated—just as the subprime debacle was about to explode.

So as the dust settles on a disruptive decade, how does an investor prepare for the next 10 years? To form a 10-year scenario, one would observe that this year’s massive rally has quickly erased an undervalued stock market. On the other hand, stocks today are not anywhere near the overvalued level of 30 to 40 PE ratios (stock price divided by earnings) that defined the market in 2000.

Today, many large high-quality U.S. companies have reasonable valuations, with PE ratios below 15, low debt and global exposure. Things that have always worked well for investors will continue to apply—don’t overpay; seek companies with strong balance sheets; look where others aren’t; minimize your trading; and increase your purchases during stock declines.

Also, ignore the groups who have proclaimed long-term investing dead. Unfortunately, you don’t get that by listening to the mainstream financial media today. They are busy discussing things like “the January effect,” the first five trading days of the year, and even the Super Bowl indicator.

When an investor adjusts his mind-set to thinking in the context of the next 10 years, those short-term discussion topics become trite and meaningless. You don’t need to know next month’s employment numbers or the level of housing starts to begin building your portfolio for the next decade.

Finally, considering stocks have returned nothing for 10 years, a conservative forecast might assume a 7-percent annual stock market return in the coming decade. Even this modest rate of return would carry the Dow Jones industrial average well above its all-time high, vaulting the index above 20,000 in 2019.•

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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.

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