Thursday, 9 February 2012

Learn from the lost decade: Look for stocks that outpace bonds & inflation, stay away from gold

NEW YORK: With only a week left in 2011, the Standard & Poor's 500-stock index has a dubious distinction: Its performance has been far worse than that of a basic basket of bonds in the last 12 years. But while betting on a large-cap stock index may not have paid off over that time, it would be wrong to assume that this has been the case for all sectors of the market.

A quick glance at the numbers shows that the S&P 500 index of large domestic stocks has gone virtually nowhere since the technology bubble burst in 2000, while the
Barclays US aggregate bond index has returned more than 6% a year, on average. Yet long-term-minded investors who had the patience to hold a diversified portfolio have done much better than that in other types of equities, said Sam Stovall, chief equity strategist at S&P Capital IQ.

For instance, shares of companies that paid dividends returned nearly 8% a year, on average, since the start of 2000, based on the Dow Jones US Select Dividend index. Several specific sectors, meanwhile, including utilities and consumer staples, posted solid gains despite the so-called lost decade, the period from 2000 through 2009 when the broad stock market lost ground.

Jeffrey Kleintop, chief market strategist at
LPL Financial, is quick to point out that conservative investments weren't the only ones that thrived. Economically-sensitive sectors, like energy, also posted strong gains, along with shares of small and midsize domestic companies. They're not defensive holdings, he said.

And no matter: Although the economy has hit some rough patches, the S&P 400 midcap index and the S&P 600 index of small-company shares have each returned more than 7%, annualised, since 2000. Although that's below their long-term historical average, it outpaces both bonds and inflation. Emerging-market stocks, too, have enjoyed a strong run in recent years, even though they sank in 2011.

What does this disparate group of winning equities have in common? One feature jumps out for James W Paulsen, chief investment strategist at
Wells Capital Management. "They're not largecap tech," he said. He noted that at the end of the 1990s, the S&P 500's performance was driven largely by a handful of the biggest growth-oriented stocks found mainly in the technology sector.

"Underneath that group, you had a lot of other types of stocks, like small caps and defensiveminded shares, that were actually being pounded," Paulsen said. "But the tech boom covered that up." In other words, the performance of these equities was really about valuations.
William Reichenstein, a professor of investment management at Baylor University, points out that in January 2000, the price-to-earnings ratio of the S&P 500, based on 10 years of averaged earnings, was 43.8. That's more than double the average of around 19 since 1953, he said, which would help explain why blue-chip domestic stocks have fared poorly so far in this century.

Yet smaller stocks, dividend-paying defensive issues and emerging-market shares were all being overlooked back in the late 1990s, and, as a result, were trading at relatively attractive valuations. Of course, all of this raises the question: What types of stocks are likely to outpace the broad market in the coming years because of their appealing valuations today?

Jack A Ablin, chief investment officer at
Harris Private Bank, argues that because of the steep losses that emerging-market stocks suffered of late, their prices are starting to look attractive again. "As the emerging markets got hammered this year, they went from trading at a 15 to 20 percent premium to the S&P to trading at a 15 to 20 percent discount," he said.

Duncan W Richardson, chief equity investment officer at Eaton Vance, argues that the investing landscape is not so clear-cut as it was after the tech bubble burst a dozen years ago. Back then, he said, the market was divided between large technology stocks and everything else, with tech stocks looking frothy and many other parts of the market priced attractively.

"Today it's more of a horse race between equity categories," Richardson said, noting that this makes picking the winners that much harder. At the very least, investors can try to steer clear of making big bets on the potential losers. "One key is to avoid becoming enamored with a glitzy asset class - especially after a long period of dramatically good returns," Reichenstein said.

He noted that tech stocks in the Nasdaq composite index disappointed investors after their surge from 1995 to 1999. In fact, nearly a dozen years after its peak at 5,048, the Nasdaq is back only to 2,618. Similarly, he said, "after the dramatic returns of Japanese stocks in the 1980s, the Nikkei index is selling at less than one-fourth its 1989 closing price 22 years later."

What does that mean for investors? Well, Reichenstein said, "now may not be the time to load up on gold."