>Understanding the Myth of the Lost Decade

A lot has been written with more to come about the lost decade for equity investors. While it is true that the S&P 500 lost about 10.0% and the government bond market gained 81.82% from 2000 through 2009, the performance profile is lopsided and understates larger discrepancies occurring in other asset classes.

However, before looking at the bigger picture, it is important to break down the returns of the past decade into two time periods: 2000 through 2002, and 2003 through 2009. During the first period, equities lost 37.59% while the bond market gained 35.0%. The strong performance from the government bond market was largely due to the flight to quality following the collapse of the dotcom bubble and the 9/11 terrorist attack in the US. These events forced the Federal Reserve to push the Federal Funds rate down to 1 percent.

During the following seven years, equities and government bonds gained 42.9% and 34.7% respectively. Importantly, during this period, the total return from the bond market was entirely due to interest income. Government bonds were actually down 1% in price over the same period. Conversely, the price return generated from the equity market was 24.5% over this period.

The biggest story about the lost decade is the complete dominance of emerging market equities. The MSCI emerging market index gained 102.4% during this past decade, a significant difference compared to the 10% loss by the S&P 500 over the same period.

The absolute outperformance of emerging market equities over domestic US equities is a continuation of the outperformance from the preceding decade, when the MSCI emerging market index gained 2,408% versus a respectable gain of 432% for the S&P 500. During the 1990s, the government bond market produced a total return of 105.3%, of which only 2.1% was earned from capital appreciation.

Over the entire 20 year period (1989 - 2009), emerging market equities produced an annualized return of 21.7% compared to just 8.1% annualized for the S&P 500. The bond market returned 6.8% annually over this same period of which a very meager 0.70% was attributed to price improvement.

Clearly a key take-away from the return data is that, over long periods of time, returns from the bond market are generally produced from the compounding of interest income rather than from price appreciation.

To read the full report: LOST DECADE