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We have come a long way from the days of high expectations and rampant greed. In a relatively short period of eight years (1994-2002), we have witnessed the greatest bull market of our lifetimes and the greatest bear market of our lifetimes. Even now, as we are seemingly emerging from a prolonged bear-market experience, there seem to be few lasting economic scars that will disfigure a broad-based economic recovery that is in the wings for 2003 and 2004. How bad was the bear market? It depends on what constitutes the “market” and what time period we're talking about. If we use the Dow as the benchmark “market” for investors, the bear market has not been all that bad within the context of one market cycle. If we choose the low point in December of 1994 as the starting point of this stock-market cycle, we experienced a bull market rally that increased the price of the Dow by 219%. The ensuing market decline amounted to a loss of 38%. Obviously, a 38% decline is unpleasant for all investors, but over the entire stock-market cycle the Dow rose from 3,675 to 7,286, a 98% increase. Add in dividends, which are not included in the index, and the total return was closer to 130%, or 10.9% compounded annually. If one chooses the Nasdaq as the basis for comparison, the story is very different. From the market low in December of 1994 through October of 1998, the Nasdaq demonstrated a rather normal bull-market pattern. However, the easy Fed policy that followed the financial crisis of 1998, coupled with the enormous technology outlays to protect businesses from the risks associated with Y2K, set off a Nasdaq explosion. The index rose to a peak of 5,048 in the first quarter of 2000. The Nasdaq's increase from late 1994 was a phenomenal 602%. Once the technology bubble burst, however, it plunged — losing 78% of its value by early October 2002. According to Morningstar, the total return of the Nasdaq from October 1994 through September 2002 was 53.4%, or a compound annual return of 5.5%. So, an aggressive investor who bought the equivalent investment in Nasdaq in late 1994 is still ahead of the game over the complete market cycle. Want a fixed-income comparison? Suppose a conservative investor, concerned about loss of principal, chose to roll over 3 month Treasury bills as a viable investment option. According to Morningstar, that investor realized a compound annual return of just 4.86%, less than half the return of the Dow Jones over the same period. How about long-term investors in fixed-income securities? For safety, an investor might have chosen a government bond portfolio, one that that was invested similarly to the Lehman Brothers Government Bond Index. Over this same time period, an equivalent fund of these bonds (before expenses) would have returned 8.57% annually, above the return of the Nasdaq, but below the returns of the Dow and S&P 500. The bear market of 2000-2002 is not like any bear market we have seen. The bear market in the early '30s correctly predicted an economic catastrophe brought about by flawed fiscal and monetary policy and an enormously disruptive trade barrier. Unemployment skyrocketed, peaking at 37.6% in 1933, while the per capita money supply fell by approximately 30% from 1929 through 1933. During this same period prices fell by 10%. To complicate a collapsing economy, President Hoover raised personal income taxes. The politicians and bureaucrats couldn’t make any more bad economic decisions; by 1933 they had made them all. The bear market of the mid-70s was characterized by double-digit inflation, encouraged by President Nixon’s abandonment of the gold standard, the implementation of wage and price controls, and the competition from fixed-income securities that yielded double-digit returns. Yes, President Nixon raised personal income taxes, too. At the peak, the maximum personal income tax rate was 77%. The first bear market of the 21st century had a lot to do with an enormous boom and near-bust in technology spending coupled with the perceived business opportunities offered by the Internet. The government played a role in undermining the economy as politicians encouraged the continuation of a constrictive fiscal budget surplus that drained stimulus from the economy. A budget surplus is contractionary because the government, in effect, raises taxes to buy back debt. Fortunately, the error was quickly undone in the last year and expectations for budget deficits ensure that fiscal policy will be pro-cyclical for some time to come. Congressional budget analysts say annual budget deficits could approach $900 billion. (Don’t panic, these guys never are accurate, even within a two-year timeframe.) Even though the stock market fall has encouraged pessimism, we do have a lot to be thankful for. Here's a nice thought to carry through the holidays:
Once upon a time, idealists imagined that America could have low interest rates, affordable energy, full employment without inflation, and broad access to home ownership. Stocks, bonds, and mutual funds, once the province of the rich, would become the domain of the middle class. The poor would be less dependent on welfare. Global trade would accelerate. We’d somehow learn to compete with the Japanese. And the men in the gray flannel suits would give way to casually attired workers of both sexes and many ethnicities. The current economy is one that economists might have considered darn near utopian just a generation ago.
— Tom
Nugent is Executive Vice President & Chief Investment Officer of PlanMember
Advisors, Inc., and an investment consultant for Wealth Management
Services of South Carolina. |
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n early 2000,
few, if any, of the optimistic market observers foresaw the stock-market
decline that would characterize the first three years of the 21st century.
After the threat of a Y2K meltdown fizzled in early 2000, market optimists
abounded. Books were written that forecasted a “roaring” stock market,
some making forecasts of a Dow Jones Industrial Average above 36,000,
or even above 100,000. This optimism attracted many new investors to the
stock market, especially as the new millennium began. 
