Only 11 percent?
As the market spent the last half of the ’90s spiraling upward, the traditional wisdom was shouted down. “The business cycle has been abolished!” cried the apostles of the New Economy. “Day trading works!” they said. “Don’t ask if companies make money!” You don’t get it, was the message to naysayers. The Internet has changed everything, and you don’t get it.
The new conventional wisdom held up longer than anyone had any right to expect. For five straight years, from 1995 to 1999, the Standard & Poor’s 500 Index enjoyed returns greater than 20 percent. The “tech-heavy” Nasdaq saw returns of more than 80 percent in 1999 alone.
Then came 2000, which saw the start of what may become one of the tougher bear markets in U.S. history. The downturn has accelerated this year, and now, according to the broadest measure, the stock market is down 28 percent from its high, with the Nasdaq down a whopping 63 percent despite reducing its technocentricity.
As we emerge from technotopia, we have a right to feel disoriented. Where are we? What went wrong? When are we getting our money back? And most of all: can it be that some of the old rules were right after all?
These aren’t the kinds of questions to which prudent investors should be seeking easy answers. The ability of anyone to call which way the market is going over the short term–short being defined as any period less than five years–is pretty bad.
However, if you wanted an answer as to when money is going to be back in our collective pockets, one way to take a stab at it would be to consider history. Over the past 75 years, the annualized return of U.S. stocks has been about 11 percent, and if you’re a bit of a stock connoisseur, you’ve seen that number often quoted as the expected return of stocks over the long term. At an 11 percent rate of return, compounded annually, the Nasdaq would return to its March 2000 high of 5048 in 2010. But who says we can expect 11 percent any time soon?
At the height of the bull market, intoxicated by New Economy fumes, we embraced expectations well beyond history’s already generous rewards. A Paine-Webber-Gallup survey in December 1999 showed that the average investor expected 19 percent annual returns over the coming decade.
That was completely unreasonable.
In looking to assess what is most likely to happen in the stock market, you could do worse than to confront recent evaluations on the subject by John Bogle, founder of the Vanguard Group, and Warren Buffett, who created the Berkshire Hathaway group–men who regularly show up at the top of lists of the most influential investors of the 20th century. Knowing that investor expectations were way out of line in late 1999, Bogle and Buffett questioned the likelihood of 11 percent market returns following the huge run-up, which actually had started in 1982. Using different mathematical approaches, each argued that the S&P 500 would most likely return 5 or 6 percent annually over the next 10 to 20 years. Apply that average to the Nasdaq, and–whammo!–at 6 percent annual returns it will be 2019 before the Nasdaq returns to its peak of 5048 in 2000.
Too bearish to even think about? Consider the fact that Japan’s market is no higher today than it was 16 years ago.
Buffett and Bogle were talking about the S&P 500, not the Nasdaq. But the fact remains: despite what you may have heard, corporate earnings are not dramatically up in the age of the networked economy. In fact, they are lighter than in the days of disco. The 1970s saw corporate earnings growing faster than they actually grew in the two decades that followed. And ultimately, stock-market rewards must do no more or less than track the real earnings of real companies.
So counting on an 11 percent average annual return in the stock market for the next 15 years makes pretty good sense only to the extent that you think Bogle and Buffett are uninformed. But if 11 percent expected annual returns have been undermined by the recent past without our noticing, are there some other pieces of the old conventional wisdom that are similarly out of touch with today’s realities?
It’s worth thinking about.
You don’t have to have bought into any New Paradigms to be open to the possibility that the old conventional wisdom was never as perfect as it was purported to be, was a bit oversimplified or that things simply may have evolved in the age of a networked economy. With the extremes that the market has gone through, the landscape may have changed. Has it? Are the fundamental lessons of the past less useful today than they were before the historic run-up and run-down that we’re witnessing? Or were the lessons ever right in the first place?
title: “Weathering The Storm” ShowToc: true date: “2022-12-13” author: “Jeffrey Martinez”
Like a family holding vigil around a sick relative, Americans are living through a moment of high anxiety, carefully monitoring vital signs to see if the U.S. economy will emerge from its recent funk–or continue spiraling down into a full-blown recession. After months of indecisive indicators–one number up, one number down–last week brought new reasons to worry. The stock market had one of its worst weeks in history, fueled by bleak pronouncements from high-tech bellwethers like Cisco and Compaq, and growing fears about whether the latest Federal Reserve rate cuts, expected this week, will be enough to get the economy back on track. The Nasdaq index lost 8 percent of its value, putting it nearly two thirds off its peak last year. The Dow closed below 10,000, ending its biggest one-week point drop in 11 years. The broader S&P 500 Index is now down 25 percent from its peak last March. For folks keeping score at home, that marks the start of the first bear market in half a generation.
Even if the markets rebound this week, the larger picture remains troubling. How scared should you be? Wall Street’s slide comes just as the underlying economy teeters near recession. Until last week most pros were betting we’d dodge a serious slowdown. Those hopes are fading fast. Consumer spending, which fuels two thirds of the economy, has held steady so far this year despite steep drops in consumer confidence. But that may change as the imploding stock market persuades shoppers to keep a tighter grip on their wallets. That could imperil the Bush administration’s tax-cut plans as the slowing economy reduces the surpluses the president hopes to distribute back to taxpayers. In the latest NEWSWEEK Poll, 71 percent of Americans say a recession now seems somewhat or very likely over the next year. Fifty-five percent say they’ve already delayed or canceled major expenditures on items like cars, home renovations or vacations, and 69 percent plan to limit those purchases further in coming months. Economists call this market-driven stinginess the “reverse wealth effect,” because it describes how people curtail spending as asset values fall and they feel less wealthy.
In the wake of the market’s collapse, some experts see an economy at a precarious crossroads. The next few weeks will be crucial as consumers weigh the stock-market damage and adjust spending accordingly. “People are starting to check their 401(k) statements and get a real sense of what this means to their net worth,” says Mark Zandi, of economy.com. “This is a big-time crisis. We’re as close to a recession as you can possibly be without being in one.”
Many families are already battening down the hatches. Rich and Kay Haddaway of Ft. Worth, Texas, saw 50 percent of their net worth evaporate in tech stocks last year. The result: instead of vacationing somewhere exotic (past trips include France and Costa Rica), this year “we’re talking about going to a lake in Michigan,” Kay says. Teena McMills, a 40-year-old Dallas widow with two daughters, is scrutinizing expenses after watching her portfolio decline 20 percent. “This year I’m saying, ‘Can I afford to send the kids to camp? Can I afford to go to Disney World?’ " Her family has substituted home-cooked pizzas for nights out at California Pizza Kitchen. At Terri and Wally Manns’s house in Rocky River, Ohio, the family huddles under afghans to watch “Buffy the Vampire Slayer” because they’ve lowered the temperature from 75 to 65 degrees. “It’s a shaky economy, energy bills are through the roof and we’ve got to cut where we can,” says Terri. Michael Young, a 35-year-old owner of a security-systems business in Miami, lost most of his life savings during a horrendous introduction to margin trading. His $70,000 initial investment is worth just $14,000, and he’s put off plans to buy a house and get married.
The Wall Street storm has so far hit different sectors of the economy with different force. Shoppers actually bought more in the first months of 2001 than the year before, though growth in spending has slowed year over year. Sales of household appliances, electronics and furniture have dropped sharply, but car sales, after a big dip in December, have rebounded. Home sales remain solid, too, buoyed by interest-rate cuts. Among retailers, department and specialty stores are suffering, while discount chains like Wal-Mart are doing well as shoppers become more value conscious. Fewer folks than usual are buying new clothes. At grocery stores, vegetables are outselling meat. “This is a very cautious consumer who’s focusing on the basics,” says analyst John Pitt, of Instinet Redbook. “It’s toilet paper and rice now.”
Not for everybody–at least not yet. Before last week’s wild ride, at least, many high-income shoppers had kept right on buying. Sales of $400-and-up Manolo Blahnik shoes have risen 60 percent so far this year. Business remains robust at Boston’s Giuliano Day Spa and Manhattan’s trendy Bumble and Bumble hair salon (where Gwyneth Paltrow gets her dye job). At high-end restaurants–Wild Ginger and El Gaucho in Seattle, Tabla and Gramercy Tavern in New York–tables are still jammed.
Experts cite several reasons consumers haven’t pulled back their spending more quickly. Employment remains a bigger driver of spending than the stock market, and unemployment remains quite low. David Medlock, a sales rep for WBT Radio in Charlotte, N.C., saw his stock portfolio drop 45 percent in the last year, but he’s unfazed. “My spending is more related to what I’m making than to what the market is doing,” he says. That calm comes through in surveys, in which investors say they plan to stay the course and not make big moves out of stocks into safer investments. Those surveys also suggest that consumers remain optimistic about their own finances even as their outlook for the economy as a whole darkens. “I’m worried for the country, but not for my family personally,” says Tony O’Brien, a Boston emergency medical technician.
But consumers may take weeks to recognize the full extent of the stock-market carnage. And the big question will be how much of a damper that will put on spending for the rest of the year. Among the hardest hit will be retirees, who depend on their investments for income, or those nearing retirement who kept too much in stocks. At the Rosedale Golf and Tennis Club near Bradenton, Fla., retirees routinely come in from 18 holes more concerned about how the market performed than whether they made par. Fred Booth, 65, didn’t get too caught up in the tech boom, but his friends did. “They’ve been joking that they’re going to have to go back to work,” he says. For the rest of us, there are reasons to hope the stock market may have less impact on spending than is commonly thought. Yes, nearly half of all Americans now own stock, but much of it is locked in 401(k)s that younger investors can’t access for decades, which limits its effect on current spending. Other investors rebalanced portfolios during the bull run, locking in gains. And don’t forget the economy’s less fortunate: half the population still doesn’t own stock. But even if they escape the reverse wealth effect, they’ll feel the psychological impact of seeing lots of scary headlines.
This week, as Greenspan & Co. decide how much further to lower rates, the rest of the nation’s financial intelligentsia will begin plugging the downsized market data into their models. “I don’t see anything that’s going to bring consumer spending back,” says Carl Steidtmann, PricewaterhouseCoopers’s gloomy chief retail economist. Meanwhile, far from Wall Street, smaller financial dramas are still being written. One afternoon last week Cynthia McKenzie, a nursing assistant with three kids, tried on three pairs of sandals at George’s Shoes in Jamaica Plain, a Boston neighborhood. She held onto a black and white pair wistfully. You could almost see her neurons wrestling with the eternal question: to buy or not to buy? “I don’t have the money this week,” she told the clerk. She exited the store, her belt a notch tighter, at least figuratively. The fate of the economy now rests on a billion such small decisions, played out in store aisles in the weeks ahead.
