Wall St did better during the Great Depression

By Stephen Foley in New York
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The Independent Online

For investors in the US stock market, the Noughties were worse than that. Even adding in dividends, the S&P 500, the broadest measure of US equities, is down about 1 per cent since the start of 2000, a terrible result given that inflation has reduced the value of those holdings further. Getting back to nought requires a Christmas miracle.

Share prices are locked on course for the worst decade ever. Ever. Not even the 1930s, the period of the Great Depression, was as bad for stocks. Comb the records right back to the start of reliable measurement in the 1820s and nothing comes close. Yale University data shows that stocks fell at an average annual rate of 0.5 per cent over the Noughties, compared with 0.2 per cent in the Thirties, the only other time the calendar shows a negative result.

The experts will point you to the calendar before anything else. We are measuring between two arbitrary points, they will say, with a dot.com bubble bursting right after the start of the decade and an all-out financial collapse at the decade's end. Overhyped dot.com stocks in the mix meant valuations were impossibly high when the new millennium dawned.

Jeffrey Kleintop, the chief market strategist at LPL Financial in Boston, says: "Market cycles don't fall neatly into decades. We were optimistic at the start of the decade, we are pessimistic now. We did see earnings growth – of 23 per cent from the end of 1999 to the current quarter – and dividends provided returns of 15 per cent over the decade, so the main drag on returns this decade was valuation."

Donald Marron, a former member of the White House council of economic advisers and now visiting professor at Georgetown Public Policy Institute, says: "If you want to play the blame game, the first group to blame are the irrationally exuberant investors back in 1999, who pushed valuations to levels that set us up for a tough decade."

Investors largely decide whether to buy or sell stocks based on their price-earnings ratio, a measure of the stock price relative to the profits being generated for shareholders. So while the price side of the equation is crucial, so too is the earnings side – and too many of the profits that were conjured up over the decade turned out to be unsustainable.

"We fundamentally over-allocated resources to housing and the financial sector," Professor Marron says. "We simply had too many mortgage bankers and repackagers running around and too many people building houses."

Strategists are debating other possible contributing factors for the dismal performance of equity markets, from the reduction in dividends paid by companies (they switched to buying back stock instead, because capital gains began to be taxed at lower rates than dividend income), to an ageing population, which is advised to switch into safer bonds as retirement nears. But there is remarkable consensus on one major cause: the economy was distorted by cheap credit.

Low interest rates in the US, set by the Federal Reserve, and a wall of money loaned from booming emerging markets, inflated a bubble, it is now clear. "We inflated a lot of trading of structured debt, a whole lot of people were employed in the mortgage industry, a lot of activity was generated on Wall Street in these businesses carving up and carving up risk, but nothing was being added to the equation. They really didn't build anything in the productive economy," says Mr Kleintop.

Michele Gambera, the chief economist at Ibbotson Associates, says the next decade holds more promise, if only we learn that lesson. "We don't know what the next big thing will be, but if we have good infrastructure and a population that is educated in maths and computers, we will get there faster."