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.
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. He wants to know what's on your mind, so feel free to send him your questions about the stock market! He'll answer as many as he can in his weekly column.