Featured Wealth Management Article
Looking Back at Decades of Equity Investing:
Insights for the 2020s
by Robert M. Cheney, CFA, CFP® Dated 12/10/20
As we approach the end of the year, it is time for the 2021 stock market forecast season. We are also entering a new presidential term and a new decade. Many forecasters and strategists are making their predictions for where the stock market will finish at the end of 2021. Over my more-than quarter century of experience, I have found that the yearly predictions of strategists generally have been inaccurate, of little value to investors, and that a year is actually a very short period over which to make predictions. Guidance over a 10-year period may prove more helpful. What insight does my experience offer for the new decade of the 2020s? It will help to first reflect on past decades.
Looking at a broad measure of the US stock market, such as the S&P 500 Index, over the last three decades, you might think of the Charles Dickens quote, “It was the best of times and it was the worst of times.” Or, as I like to say: “It was the best of times before it was the worst of times followed by the best of times again.” As you will see below, overall stock market returns, and the performance of individual asset classes, over these three decades, were extremely variable. For this reason, investors may consider having continuous exposure to all of them. Looking at decade-long periods, there appear to be cyclical patterns to performance for asset classes. In the 1990s, many investors became complacent about diversification beyond large cap and technology asset classes because of the outperformance of those stocks. These investors had a difficult experience in the 2000s and faced negative returns. Noting the outperformance of US large cap and technology asset classes again in the 2010s, there may be a strong argument to make sure that small cap and value stocks as well as international and emerging markets asset classes are represented in your portfolio for the decade ahead.
The Go-Go 90s
I commenced my investment career as an equity research analyst in the 1990s during the “dot-com boom.” During the 1990s, we experienced the best of times and the S&P 500 had total return of 18.21% per year during a very strong bull market and dot-com innovation. All equity asset classes moved in tandem in the 1990s, with each showing positive return as shown in the accompanying chart. When we consider that over even longer timeframes, stocks tend to return 9-10% on average, it is worth noting how much above-trend the returns of both the S&P 500 Index (18.2%) and particularly the technology-heavy NASDAQ Composite (24.50%) were and how much lower than trend small cap value stocks represented by the Dimensional International Small Cap Value Index (3.33%) were.1
The “Lost” Decade of the 2000s
For US large-cap stocks, the “lost decade” from January 2000 through December 2009 resulted in disappointing returns; the S&P 500 had a total return of -0.95% per year after giving stellar returns the previous decade. For large-cap domestic investors, the 2000s were the worst of times and investors only exposed to the S&P 500 Index or domestic growth stocks considered the decade “lost.” This decade included two significant bear markets; it started with the “dot-com bust” and concluded with the Financial Crisis. It is also worth noting that after blow-out returns in the 1990s, the NASDAQ reversed and returned -5.67% per year in the 2000s. I often remind my clients who have significant existing exposure to tech stocks, such as start-up founders and management of technology companies, that we have previously witnessed a long period of underperformance in technology and the NASDAQ after periods in which they have significantly outperformed.1
However, despite these bear markets in the 2000s and the disappointing returns for large domestic and technology stocks, it was a solid decade for investors who diversified their holdings globally beyond US stocks and included other parts of the US stock market like small-cap and value stocks in their portfolios. Of particular note, after below-trend returns for Dimensional International Small Cap Value Index in the 1990s, this asset class provided above-trend returns in the 2000s of 13.70% per year. US small cap and value stocks as well as international and emerging markets stocks were solidly positive in the 2000s, offsetting disappointing returns from US large cap and technology. A portfolio incorporating all these asset classes provided a positive performance for the decade.1
The Rebounding 2010s
The next decade also flipped the script. For US large-cap stocks, the 2010s were the best of times again as the stock market recovered from the Financial Crisis and entered the longest bull market on record, lasting the full duration of the decade. From January 2010 through December 2019, the S&P 500 Index earned a strong total return of 13.6% per year. After negative, below-trend returns from S&P 500 Index and NASDAQ in the 2000s, these asset classes returned to above-trend returns in the recent decade. NASDAQ went from solid negative returns in the 2000s to returning a strong 14.74% yearly in the 2010s.1
Although all asset classes moved in tandem and each provided positive returns, contrary to the 2000s, diversification into US small cap as well as international and emerging markets in the 2010s actually brought down returns like the 1990s. Returns from Dimensional International Marketwide Value Index (5.57%) and Dimensional Emerging Markets Index (4.60%) were below-trend and lagged the performance of large cap and technology.1
What Do the 2020s Hold in Store?
The last three decades reinforce timeless market lessons for investors: returns can vary sharply from one period to another. I am not claiming that asset class performance will vary right on a decadal schedule. In fact, at time of writing, 2020 has carried on the investment themes of the 2010s: year-to-date, the S&P 500 Index (13.54%) and NASDAQ Composite (40.24%) are again above-trend and outperforming the other asset classes. Just like the timing of overall stock market returns, it is extremely hard to time the outperformance of asset classes. For that reason, investors may consider having continuous exposure to all of them.
Noting that international value, small cap value, and emerging markets stocks have performed under-trend in the 2010s and most of 2020, these could be particularly important asset classes to have represented in your portfolio for the 2020s. This would represent a form of “reversion to the mean” for these asset classes. There also may be a discounted valuation argument to be made for international value, small cap value, and emerging markets stocks relative to their historic average valuations and relative to the valuation of US large cap and technology stocks (i.e., that these stocks are cheaper right now). If the previous decades are any lesson, then the returns from the S&P 500 Index and NASDAQ Composite for the reminder of the decade could result in disappointment, and growth-focused investors may wish to reconsider their portfolio allocations. Again, it is very hard to forecast when these trends may start and finish. However, since the beginning of September 2020, we have seen US value and small cap stocks as well as international and emerging markets stocks outperform US large cap and technology, perhaps representing a change in stock market leadership. Could this be a “tell” for performance through the reminder of the decade?
Holding a broadly diversified portfolio can help smooth out the swings regardless which asset class is performing. Having a sound investment plan built on diversification – and sticking to it through good times and bad – can provide rewarding investment results. Nobody knows for sure what the next decade will hold, let alone the next year. Maintaining patience and discipline puts investors in a position to increase the likelihood of long-term success, regardless of predictions.
1 Source: S&P Global, Macrotrends LLC, Dimensional Fund Advisors