| First of all, I'm
going to make a daring forecast -- if the Dow Jones Industrial Average keeps growing at
the rate it has for the past century, it will be at
30,000,000,000,000,000,000,000,000,000,000,000,000 when we reach Y3K. Of course
that's give or take a few gazillion points. So if your investing horizon is at least a
thousand years, I recommend that you put all of your money in equities.
If your time horizon is shorter, you would probably prefer
to see my predictions for a less lengthy period -- such as over the next decade. They
might not be as specific as my end-of-the-30th-century projection, but then again there is
a chance I might actually be held accountable for them.
The year (and century) in review
Before I look into the future, let's review the past year,
and century. The S&P 500 gained 25% in 1999, the fifth consecutive year it increased
by at least 20%. The Russell 2000 (an index of small capitalization stocks) earned 23% for
the year. Of course, the booming sector of the market was Internet and other technology
stocks. Broad-based international stocks returned 31%, with emerging market equities
gaining 71%. The only disappointing investment last year was bonds -- the Merrill Lynch
Bond Index gained only 3% for the year.
Now, it must be noted that the past few years have been
exceptionally kind to investors. To put things in perspective, one should consider
longer-term returns. For the 1900s, large capitalization stocks earned 11%, while bonds
earned an average of 5%.
Looking into the future
Let's look at what I expect the stock market to do in the
'00s.
First of all, in my opinion the overall stock market will
not even come close to the consistent 20% returns we have been observing the past few
years. We will likely see a return to normalcy over the next decade. The recent run-up in
stock values has been unprecedented in its stability, but if there is a clear lesson one
can learn from the past, it is that extraordinary times do not last -- if you don't
believe me, ask people who invested in Japan 10 years ago.
Moreover, I believe that technology stocks will earn
returns much closer to the overall market, although they should still slightly exceed it.
Three factors contributed to their meteoric rise:
- The unexpected growth of the Internet.
- The relatively low amount of competition.
- The leanness of the companies in those markets.
Well, here's where we stand now:
- We all know about the growth of the Web.
- There is tremendous competition among the firms, and
although some will be very successful, others will suffer disappointments, which will
detract from the returns of the sector as a whole.
- As many of the companies have grown, so have their
bureaucracies. The related additional costs will detract from their value.
I think we will experience some significant volatility in
the next few years. Over the past few years most companies have been meeting or exceeding
their earnings forecasts. However, that type of performance can't continue forever -- and
we will see a drop in values the first time it doesn't. Even with the relatively smooth
rise in stock values since 1994, there have been signs of price instability -- October
1997, August 1998, and July 1999 are three examples. We can expect longer periods of price
risk in the coming years.
Inflation should remain under control, in my opinion. The
Federal Reserve Board has proven to be hawkish in controlling price levels. The economy
has achieved tremendous growth without inflation because of continued increases in
production efficiency. However, I think the Fed will increase interest rates at the first
sign that improvements in efficiency are stopping. Although I think this will slow the
economy -- and cause a decline in stock values -- it will also keep a lid on inflation, in
my opinion.
Keep your expectations realistic
Despite what some might say is a pessimistic outlook on the
economy, I think investors with long time horizons should put a significant proportion of
their money in equities. Of course they should do so with realistic expectations. If you
are expecting a 20% return with no downturns you are bound to be disappointed. However,
while a 10% overall return with two or three dips maybe not be what you have recently
become accustomed to, I think it still is better than putting all of your money in bonds.
One final prediction -- various pundits will urge you to
switch all of your money out of stocks at least four times over the next decade. Just in
the past 18 months we have been told that we should sell because of a certain economic
recession (summer of 1998) and the Y2K bug (fall of 1999). And that doesn't count Money
Magazine's infamous three-word cover page of 1997, advising investors to "Sell Stocks
Now" (when the Dow was at less than half of its current value). So the best advice I
can give is "don't listen to pundits who seemingly know the future".
After all, you're one up on them -- I've already told you
how the millennium will end.
 Lummer's Logic Archives
Scott L. Lummer, Ph.D., CFA, 401k Forum's Chief Investment
Officer, is a recognized expert in the investment field. He has conducted extensive
research on asset allocation, international investing, risk management, mutual fund
analysis, ethics and valuation, and is a co-author of The Pension Investment Handbook.
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