In Search of the Lost Decade
For several years analysts have been complaining about a
“Lost Decade” for stocks. Judging by the big U.S. stock market indices, the
market has been flat for 13 years. But the Dow Jones Industrial Average and the
Standard & Poors 500 reflect primarily the performance of large companies.
The picture is much different if one looks at the broader
stock market. According to an analysis by Standard & Poors, over the 10
year period from March 24, 2000 (the peak of the tech boom) to December 2,
2011, the S&P 500 declined by 19 percent.
As we’ve noted, the index counts big companies more heavily.
Just 10 of the 500 companies account for 20 percent of the performance.
If instead you weight
each company in the index equally, the index would have climbed by 66 percent.
To put this in actual dollar terms, if you had invested $10,000 in the S&P
500 on March 24, 2000, you would have had only $8,100 left at the end of the
decade. If you had put equal amounts into each of the 500 stocks included in
the index, your investment would have grown to $16,600 --- more than double the
$8100 if invested in the S&P 500.
This isn’t an esoteric discussion about constructing
indices. It points out the dramatic benefits of diversification. Most people acknowledge that no one can
predict the future. If that is so, no one will know whether to hold big
companies or small ones, U.S. banks or Asian telephone companies.
Investing with wide global diversification increases the
chances that the investor will own the stocks that do best. Over time owning
the winners helps more than owning the losers hurts. Often, a small sector or a
few individual stocks can greatly influence a large portfolio over a decade.
In the recent decade, an analysis by Bloomberg showed that
energy and resource stocks appreciated dramatically. After a twenty year bear
market for oil stocks from the 1980 peak, energy stocks rallied by 242 percent
in the five years after October 2002 while material producers appreciated by
162 percent.
Meanwhile some of the biggest companies, which had done the
best in the 1990s, suffered throughout the decade. General Electric, once the
most valuable company in the world, dropped by 67 percent during the decade.
Cisco Systems, a miraculous growth stock in the 1990s, at its peak was also the
most valuable company in the world and appeared to be heading to be the first
“trillion dollar company.” Cisco has
dropped by 82 percent over the decade to $100 billion.
Most U.S. investors, whether by design or chance, now tie
their fate to the largest U.S. companies. According to S&P, some $1.3
trillion is indexed to the S&P 500 while $5.6 trillion is benchmarked to
the S&P 500, one-third of total U.S. stock investments. If one counts
“closet indexers,” the totals are even higher.
It could be that big U.S. stocks have been in the dog house
long enough. Their valuations appear much cheaper than those of smaller
companies. Small companies have had a good run and nothing lasts forever. Perhaps Emerging Markets or other
international companies will take the lead. Energy stocks might drop or
precious metals might pick up the mantle.
But the clearest lesson from this data is that by placing
all your eggs in one basket, whether it’s the largest U.S. stocks or precious
metals, investors can end up with egg on their face. True diversification means
participating in wide sectors of the global economy. Some funds buy thousands
and thousands of different stocks spread out around the globe. Over time, being widely diversified has typically
lowered risk and given greater appreciation.