Iron Capital Insights

  • Iron Capital Insights
  • January 6, 2010
  • Chuck Osborne

A New Decade

It seems everywhere I look this week I see stories about how bad the last decade was. Of course the two recurring themes are terrorism and the economy, since the decade began with the bursting of the technology bubble and the day no one will ever forget – September 11.

Time is a funny thing. In one sense it seems like a lifetime ago that we were worried about Y2K, yet it seems like just yesterday I was fighting for IT resources to build a new and improved research database at Invesco. (Side note: I really don’t miss working at a big firm.) It also seems like yesterday when I was standing in the Invesco executive conference room watching, in shock, as the Twin Towers burned, while my boss, standing next to me, kept muttering under his breath, “I was just there last week.” He had been at Aon Consulting. Their offices were on the 102nd floor of the South Tower, and they lost nearly everyone.

It seems that everyone I know has a story about the tech bubble and/or 9/11. They really did define the decade, and when you look at it from that perspective it is no wonder almost every story has been about how bad the first decade of this century has been. Then, as proof of how bad the decade was, we get the worst 10-year return in stock market history (which is not actually true if you look at all 10-year periods. but is true for calendar decades).

This evidence gets used as proof that stocks won’t do well going forward, but here is a thought as we head into this new decade: there are few powers in the universe stronger than what statisticians refer to as ‘regression toward the mean.’ I can’t explain how or why, but the stock market provides an average 10% rate of return – the mean. Even after the worst calendar decade in history, the S&P 500 over the last 30 years has provided a 10.4% annualized rate of return. I once worked with a gentleman named Ivory Day who studied 30-year rolling periods of time going back as far as he could find the data. He noticed that over these long time horizons, the returns on stocks were very stable and always right around the 10% mark.

I never fully bought into Ivory’s analysis. I am in the camp that believes there must be more to the future than history simply repeating itself. There must be some reason stocks go up 10% per year on average. But here we stand and sure enough, after this most painful decade, all we did is go from the highs of the biggest 20-year run in stocks to once again revert to the mean.

We face some tough economic times ahead. Debts eventually will have to be paid, and higher taxes will slow growth. However, if Ivory’s wisdom is correct, we will be entering a pretty good decade for stocks. In fact if he is right, by my calculations we will have to average around 14% per year for the next ten years for that 30-year period to get back to the 10% mean.

Sounds a little too optimistic, but it is the beginning of a new decade and we could all use some optimism. Ivory, if you are reading this – I’m pulling for you and your theory!

Happy New Year!

Chuck Osborne, CFA
Managing Director, Iron Capital Advisors