Terrible Decade for Stocks – and Optimism for Next 10 Years?

In January 2000, the S&P 500 Index stood at about 1,425 and today sits at 1,125.

If you started investing 10 years ago you have probably grown an ulcer. All your efforts of time and money for 10 years have been rewarded with a big, fat nothing, zip, nada, zero. It is depressing. It is humbling. It is discouraging and frustrating.

However, what it should not do is demoralize you for the next decade. In fact, quite the opposite

Even though the past decade brought negative returns, we need to remember three important points:

1. This isn’t the first time it’s happened.
2. It’s never happened two decades in a row (if we begin with years, ‘00, ‘10, ‘20, etc.)
3. The following decade after a negative-return decade has proven to be consistently good.

Yale economist Robert Shiller keeps a database of S&P 500 prices going back to 1871. Taking his data and breaking it into 10-year periods shows the following returns:

Period -   S&P 500 Return

1880-1890        5.28%

1890-1900       13.38%

1900-1910        65.25%

1910-1920        44.75%

1920-1930     145.87%

1930-1940     (43.34%)

1940-1950       37.24%

1950-1960     243.78%

1960-1970       55.63%

1970-1980      22.80%

1980-1990    206.56%

1990-2000   319.33%

2000-2010 (21.39%)*

2010-2020         ???

*As of Dec. 23.

Of course, you can tweak the starting year and come up with different results. But in general, the pattern isn’t too different. For example, starting with the fifth year of each decade:

Period -   S&P 500 Return

1885-1895      0.24%

1895-1905    98.35%

1905-1915    (11.27%)

1915-1925     41.44%

1925-1935   (12.48%)

1935-1945    45.68%

1945-1955   163.90%

1955-1965    141.91%

1965-1975    (15.75%)

1975-1985    136.49%

1985-1995    171.12%

1995-2005   153.93%

What’s does this all mean? These are big, broad tables, so the takeaway from them should be big and broad as well. After booms come busts, and after busts come booms. That’s how markets work. It becomes obvious that the single most important variable in determining future returns is the starting price. That stocks posted negative returns over the past decade should surprise no one as they started at the peak of the dot-com bubble in 2000 which meant that we needed miracles just to break even. Ditto for the late 1920s and late ’60s.

Conversely, when you start a period wrapped in pessimism the odds that you’ll finish on an up note are quite good. That’s just what happened from March of this year through today, as the S&P 500 surged over 65% even as hundreds of thousands of jobs were lost. When the starting point is formed by people who think the world is about to explode, the economy doesn’t need to achieve anything remarkable for stocks to score incredibly remarkable returns.

That’s why some of the biggest gains since March came from companies like Ford (NYSE: F), Citigroup (NYSE: C), and Sirius XM (Nasdaq: SIRI). On the other hand, Yahoo! (Nasdaq: YHOO) saw revenue shoot up nearly eleven-fold over the past decade, yet shares fell 80% during that period. I’ll say it again: The single most important factor in determining future returns is the price of your starting point.

There are reasons to be optimistic The good news is that there are currently plenty of high-quality companies trading at attractive valuations, upping the odds of strong returns over the coming decade. Check out Procter & Gamble (NYSE: PG) at 15 times 2010’s earnings. Or Johnson & Johnson (NYSE: JNJ) 13 times next year’s earnings. Others might like AT&T (NYSE: T) with a 6% dividend yield. It’s still a fruitful time to be an investor.

No one can guarantee what’s going to happen over the next decade! That you can take to the bank. But if the history of markets going back almost to the Civil War is any indication, the odds that the next decade will be more prosperous than the last are fairly good.