Stocks: What the 'Lost Decade' Means

After posting a negative 10-year return—as the S&P 500 did in October—the market tends to move sideways for an extended period

By Sam Stovall From Standard & Poor's Equity Research

Rolling 10-Year Price Returns (no dividends) for the S&P 500 1928-2008

S&P 500% Changes During Cycles of 10-Year Returns

Cyclical Bull Markets: 1966-82

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From its recent closing low of 752 on Nov. 20, until its 909 closing high on Dec. 8, the Standard & Poor's 500-stock index rose nearly 21%. And since a 20% gain off of a bear-market bottom is the traditional signal of the start of a new bull market, we can rejoice that the worst is over. Right? Well, maybe.

Since 1945, there have been 10 bear markets. In all but one, a 20% advance was eventually proven to be the start of a new bull market. This was even true in October 2002, when the S&P 500 bottomed at 777, rose more than 20% in early December, only to throw us into a nail-biting retest of the prior low by falling to 800 in March 2003.

The only time since World War II that we experienced a 20% advance that proved to be a rally within a bear market, and went on to set an even lower low, was following the September 11 attacks, from September 2001 through January 2002. But with 10 other 20% advances correctly signaling the start of a new bull market, the odds favor that a baby bull has been born. Those still in doubt can always point to the 1930s, when 20%+ rallies more frequently occurred within the confines of a continuing bear market.

If this is the start of a new bull market, however, I wouldn't expect it to be anything more than a cyclical or short-term bull, within a secular or long-term, bear market. Why? In October, we recorded our first "Lost Decade" in more than 30 years, which traditionally has pointed to a series of cyclical bulls leapfrogging cyclical bear markets in an extended period of sideways action for stock prices.

A Lost Decade

I've lost a bet, and I've lost my keys, but I've never lost a decade—until now. I've frequently heard that if you give equities long enough, they always post positive returns. After suffering through a 52% bear market during the past 13 months, I wonder how long the average holding period must be in order for this old adage to remain true. One thing I do know is that it's not 10 years!

There's one good thing to be said about having slipped into negative territory on a rolling 10-year basis, however. If history is any guide, the worst is likely behind us. Since 1923, we have had three periods in which the rolling 10-year performances for the S&P 500 rose, three in which they declined, and two in which they went sideways. As always, history is a good guide, but never gospel.

During the periods in which the rolling 10-year returns were rising, the S&P 500 posted an average annual increase of 15.3%. What's more, only 19% of all single-year returns within these periods were negative. On the other hand, during the years in which the rolling 10-year returns were falling, the average annual returns were a minus 8%, and 59% of all single-year results were negative. During the sideways periods (those years in between the rising and falling periods), the S&P 500 rose an average 9.4% and posted single-year declines only 34% of the time. The results for these sideways periods compare favorably with the average results of all years from 1923-2008, in which theS&P 500 increased 7.4% and posted single year declines 33% of the time.

Cyclical Bulls in a Secular Bear

Granted, the observations are few, and there is no guarantee that theS&P 500's price performances will be equal to or better than long-term market averages during the coming years in which theS&P 500 will likely move sideways on a rolling 10-year basis. What's more, I expect the rolling 10-year price change for the S&P 500 to worsen into early 2010, as we get closer to the Mar. 24, 2000 high in the S&P 500. But for me, this historical look back is better than nothing.

But this game of bull/bear leapfrog is nothing new. We experienced a similar rotation of cyclical bulls and bears from 1966 to 1982, in which the Dow Jones Industrial Average flirted with the 1,000 level. This 16-year period incorporated the tail end of a declining 10-year rolling period for the S&P 500, as well as its subsequent sideways period in which the S&P 500 saw four cyclical bull markets interrupted by five cyclical bears before equities started their 18-year secular bull market in 1982.