Weekly outlook

Learning to love the “lost decade”

By Tom Stevenson, 12 November 2008

History shows that stock market feast invariably follows stock market famine

You may not be familiar with idea of the “lost decade” for equities, but I suspect you won’t be able to escape it over the next 12 months or so. As an investor in stock market funds, you probably do not need telling that equities have been a disappointment over the past ten years. In the run-up to the ten year anniversary of the FTSE 100’s December 30 1999 peak, expect to see a great deal of hand-wringing in the media about the "death of equity investing". The gloom-mongers have some decent data to back up their case. The FTSE 100 has never recovered its 1999 peak, despite a valiant effort last year when it reached 6,732, just 3% shy of the 6,930 that marked the high water mark of the dot.com bubble. At Monday’s close of 4,403.9, it has fallen 19% over the past ten years and is 35% down from the peak.

"Rumours of the death of the equity are exaggerated" Tom Stevenson

Short of a miraculous bounce in the market over the next few months, the strong rise in share prices in 1999 will ensure that the ten year performance figure continues to deteriorate for a while yet.

If you factor in inflation over the same period, the picture looks even worse. Although prices have not risen at the wealth-destroying rates many investors will remember from the 1970s, inflation has still chipped away significantly at the real purchasing power of money. Over the past ten years, the UK consumer price index has risen by 20%.

This means the FTSE 100 would have needed to rise from 5,432 ten years ago to 6,518 just to keep pace with rising prices. In real, inflation-adjusted terms, therefore, the value of the average British blue-chip share has fallen by 32% in a decade.

For a generation that grew up during the 18-year bull market between 1982 and 2000, this has been a shocking development, just as the fall in house prices, if it continues, will disorientate those who have taken rising property prices as an article of faith.

After the slide of the past ten years, and in the face of unremittingly gloomy economic statistics, it is unsurprising that many are pessimistic about shares. Some commentators have looked at Japan, the most obvious recent example of an extended stock market decline, and asked whether we might yet repeat its slump, which has so far “lost” 18 years.

There are a number of reasons why I believe this is unlikely, the main one being the policy lessons that have been learned from that country’s disastrous handling of the early years of its property and banking crisis. But the main reason I am persuaded the odds are against another decade of slumping share prices is that it would be so at odds with the evidence of the past 110 years or so.

While history does not repeat itself, Mark Twain said, it does tend to rhyme and what investment history tells us is that, in the stock market, Paradise Lost invariably morphs into Paradise Regained. Buying shares at the end of a "lost decade" as bad or worse than the past ten years has failed on only one occasion since 1899 to at least maintain the purchasing power of the money over the following ten years and on average has almost doubled it. Only a very confident investor would bet against an 18-1 record.

I recently trawled through every complete ten year period between 1899 and 2007 using the data in Barclays Capital’s excellent Equity-Gilt study. The table below shows what I found. In summary:

• In 99 ten-year periods, the real inflation-adjusted capital value of shares has fallen by more than the FTSE 100’s recent 32% ten-year decline on 19 occasions.
• These declines occurred in just two clusters of overlapping ten-year periods. In every year from 1915 all the way until 1924, and again from 1974 until 1982, investors found themselves at the end of a “lost decade”. In each of these years the real capital value of the stock market was at least 32% lower than it had been a decade earlier.
• In all but one of these 19 years, investors who bit the bullet and invested in the stock market were subsequently rewarded with inflation-beating returns.
• Even the exception was not that disappointing - £100 was turned into an inflation-adjusted £92 (not great but hardly a disaster) - while investing in the best year (1979) turned £100 into £268 – that’s after inflation and without taking into account the reinvestment of dividends, both of which would have boosted the return significantly.
• The average of the 19 “lost decade” years in the 20th century turned £100 into £179 (again that’s taking account of the ravages of inflation and without any benefit from dividends).

I draw two conclusions from this short stock market history lesson:

1. The odds are overwhelmingly stacked in favour of an investor who buys shares after a long period of underperformance. The time when recent history makes people feel the most depressed about stock market investing is, almost invariably, the time when they should be most enthusiastic buyers of shares.
2. Stock markets move in multi-year cycles. This means that the opportunity to benefit from better long-term returns can exist for an extended period. This allows an investor with the faith to keep saving regularly through the trough to build up a considerable war chest ahead of the better decades ahead. Not that this is easy. Investing through the low demands steely determination because for years at a time the track record will try and persuade you to do precisely the opposite.

Over the next year or so, many commentators will trumpet the death of equity investing. History suggests they may be expensively wrong.

 

	Nov 03/ Nov 04	Nov 04/ Nov 05	Nov 05/ Nov 06	Nov 06/ Nov 07	Nov 07/ Nov 08
FTSE 100 Index *	11.5%	18.9%	19.2%	13.5%	-32.3%

^{* Source: Datastream 1/11/08. Total return basis}