By the time the stock market fell to its nadir in late 2002, the valuations of the stock market had merely reached a more historically appropriate level. From being grossly overvalued for several years, they had reverted to a more normal valuation. From that point in late 2002, into the mid- and late-2000s, the economy, earnings and stock prices grew, as real estate and other credit bubbles were inflated, thanks again primarily to the Federal Reserve. By 2007 and 2008, the U.S. economy was again in bubble territory and while stock market valuations did not appear overly excessive, they were based on a bubble economy, which logic dictated would eventually break. As the economy turned for the worse so did stock prices.
Once again, the Federal Reserve tried to come to the rescue with super-easy monetary policies as well as other monetary experiments like money-printing, exchanging banks' bad debt for good Treasury bonds, and bond market manipulation. During 2009 stock prices again soared as these effects, though inevitably temporary, covered over the structural problems of the U.S. economy. For an investor, it is not realistic to compare how the stock market has done over a relatively short period of time, and particularly when it follows a stock or economic bubble, such as existed in 2000 and 2007.
In fact, if you must compare current stock prices to a previous level in the past decade, I believe the most appropriate level to look at was the period in 2002 as the stock market was making a short-term floor. Because of the continually easy money policies during the 2000s, this period in 2002 and 2003 was about the only period in the 2000s that the stock market was not in a bubble. From that point, the U.S. stock market is up roughly 50% over the past 8 years, or an average of about 5% per year. Including dividends, the U.S. stock market was up an average of about 7% or 8% a year. That's a level comparable to its historical average, and certainly not a "lost decade".
However, the main problem with the "lost decade" idea, is that it assumes that an investor only invests for a decade or less, or simply assumes that such a time period for owning stocks is properly called "long-term". But while 10 years may be long-term for a personal relationship, owning a car or having a pet, when it comes to investing, such a time period does not really define long-term investing.
True investing means buying companies with the expectation that their participation in the long-term growth of the economy over many economic cycles will produce long-term that outpace inflation. Individuals and companies who start and run businesses don't typically have expectations of businesses that last a few years. Their expectation is to grow their business over decades, even 100 years or more. Similarly, an investor with money invested in the stock market, should think in terms of decades, not months or years.
It' certainly true that many investors' time-spans have grown shorter with pervasive 24-hour financial news channels and hourly stock market updates. However, it's also true that longer lifespans and longer retirements suggest that for most investors, their idea of long-term investing should be increasing, not decreasing. Even for a worker that is already 40 years old, he or she will probably have at least two decades of working, saving and investing, and then perhaps another two or three decades of living on those savings during retirement. A younger worker, accompanied by even better health and a longer lifespan could easily see six or seven decades of an investment horizon.
So let's look at how an investor in the U.S. stock market might have done over the truly long-term, one measured in decades. Well, looking back to 1990, just two decades ago, the Dow Jones Industrial Average was at about 2,700. So the Dow has nearly quadrupled since then, giving an average yearly return of about 7%. Including an average dividend yield of about 3%, that's about an average 10% yearly return for the two decades. During that same span, the S&P 500 index, which includes larger stocks, tripled, and the Russell 2000, which is made up of smaller companies, nearly quadrupled during that period.
Looking back three decades, to 1980, we see that the Dow Jones Industrial Average, which began the 1980s at 834, has gone up about twelve times since then, giving an even more impressive nearly 9% yearly average, not including dividends. During those same 30 years, the S&P 500 index, has gone up ten times, giving a yearly average of about 8%. Including dividends we see quite impressive returns for the U.S. stock market, if one is willing to truly look long term. Yes, the stock market is volatile and is prone to stock market bubbles, particularly with meddling Federal Reserve officials. The U.S. stock market, on average, goes down every three years and falls more than 20% every five years or so. And yes, there are periods that the stock market seems to make limited headway for years on end. During those times, it's a great time to be saving money, accumulating stocks, buying low, with the expectation of realizing future gains.
By the way, while stocks in the U.S. seem to have given meager returns for much of the past decade, many investments around the world have seen much stronger returns. The "lost decade" idea seems to assume that the U.S. stock market is the only market available for investors. Most U.S. investors are woefully deficient in foreign stocks, often with less than 10% or 20% of their stock portfolio in foreign stocks. That's surprising since most of the globe's economic activity occurs outside the U.S., and the U.S.' share of company profits on the global stage decreases yearly.
Correspondingly, many international stock markets have more fully participated in the world's economic growth. For example, looking at some major stock market indexes around the world, the Argentine and Mexican stock markets are up about five times just from the beginning of 2000. Similarly, Brazil's stock market quadrupled over the past decade. The Canadian stock market, most Asian stock markets, and most European stock markets, have also increased more than the U.S. stock market, not even including their dividends, which are often higher than U.S. companies. The Dow Jones Global stock market index, which tracks the stock market performance of most major stock markets around the world has doubled since its lows in late 2002, significantly outperforming the U.S. stock market.
It is impossible to know whether or not foreign stocks will continue to outperform U.S. stocks. However, it seems clear that foreign economies have generally weathered the latest economic downturn, some with negligible ill-effects. And as the majority of global growth has taken place outside of the U.S. in the past decade, it seems reasonable to expect this to continue to happen in the coming years and decades.
This also underscores the need for international diversification. There is no excuse anymore for a lack of diversification with your investments into foreign stocks. Over the past decade there have been hundreds of new mutual funds that invest exclusively in foreign markets, whether in large companies, small companies or foreign bonds. These options have spilled over to 401(k), 403(b)s, and their equivalent, giving workers more foreign options than ever before. The proliferation of Exchange-traded funds (ETFs) has also given investors the ability to easily invest in a global index,
specific geographic regions of the world, individual countries, and even sectors within foreign countries. In fact, one problem now is that the wealth of options can be confusing for investors, making it difficult for investors to remember to include international options for their savings.
Despite the sharp ups and downs and overall lackluster stock market returns in the U.S. over the past decade, its true long-term record is very strong. It's true that the world will need to deal with structural deficiencies in the coming years, particularly excessive debt, that will weigh on economic growth. However, for those who choose to attach themselves to the world's economic growth via mutual funds, Exchange-traded funds, or similar vehicles, while controlling costs and their emotions, will be rewarded over the long term. In the coming years and decades, there will be continued stock market volatility both inside and outside the U.S., but worldwide economic growth will march on, giving those who fully avail themselves of it the best course to secure a promising retirement and financial future.