IntroductionIn April of 2008 I started
writing about the miserable stock markets we've experienced in this
first decade of the 21st century, suggesting that things might even
They did, and then they got better in 2009, but not good enough
to bring the decade into positive territory. We have just
experienced the worst U.S. stock market decade in the past eight
decades, starting in the 1930s.
In this end-of-year commentary, I examine the past year and the past
decade, placing them into perspective relative to the long run
history of our stock markets. I discuss both domestic and foreign
The U.S. Stock Market
Stocks, Bonds and Bills in
2009 and Beyond
The U.S. stock market, as measured by the S&P 500, earned
26.5% in 2009, rebounding from a 37% loss in 2008. This recovery was
not enough to restore previous losses, however, so we've ended the
decade with an average annualized loss on the S&P of 1% per
year, well below the 84-year long term average return of 9.8% per
year. By contrast, bond performance for the year (4%) and the decade
(7.4%) was in line with historical averages (6.1%), as was inflation
(2.8%). Completing the picture, we're paying the government to use
their mattress, with Treasury bills yielding 0.15% for 2009.
Of the eight calendar decades for which we have data (1930s,
1940s…), the 2000s were the worst performing, although they were not
the worst 10-year period ever. The following chart shows the returns
of the past eight calendar decades, as well as the best and worst
10-year periods ever. There have been worse times than the 2000s:
the S&P lost 5% per year in the 10 years ending August 31, 1939
(shown in the graph), and we just experienced the worst real (return
net of inflation) 10-year loss in the period ending February 28,
2009 (not shown). Did you feel this February, 2009 loss? That decade
brought real cumulative losses of 49%, or 6.5% per year. No wonder
we feel poorer. It's been awful.
|Annualized S&P 500
Returns by Decade|
Delving deeper into the details, the next graph shows in red how
the individual years of the 2000s fared historically. Also, shown in
green are the individual years of the previous decade, which as you
can see from the graph above was a very good decade. Years like 2008
have happened before, but fortunately not very often; 1931, 1937 and
1974 were the only other years with real losses in excess of 30%.
Note also that only three of the past ten years – 2003, 2006 and now
2009 – were reasonably good. By contrast, you can see how good the
green colored 1990s were.
|84-Year Return History
for Common Stocks|
(Adjusted for Inflation)
Compounded Real Return = 6.7%
Investors would have been better off in bonds or Treasury bills
than in stocks. Do you think the next decade will be better, or
bring more of the same? Where can we invest and be safe? One place
that would have helped in the past decade was foreign markets, which
returned more than 6% per year, although they too suffered 2008
The ride to disappointment has been bumpy. First, the bubble
burst in the three years 2000-2002, and from there the stock market
clawed its way back so that investors had earned an average 3.5% per
year return for the decade-to-date as of October of 2007. We were
back even with inflation for the decade-to-date. But then the next
16 months took all of that back, and more, with the S&P
plummeting 55% from 11/1/07 through 2/28/09.
As painful as those 16 months were, we can still learn from this
experience. This is the kind of period that serves to stress-test
those investments that are supposed to be good defensive plays, and
to evaluate how well our professional investment managers have held
up. We've made back some ground in 2009, but there are plenty of
reasons to not be sanguine. In the following we review various
market segments and strategies, to show what worked in the year 2009
and in the decade, and what did not. What sectors, styles and
countries have performed best and worst? The bottom line: everything
worked in 2009, and only stocks failed for the decade. The real
questions, of course, are all about the future; an understanding of
the past should help.
The Year 2009
Style Returns in
As the exhibit on the right shows, every investment style had
substantial gains in 2009. Smaller companies gained more than 40%,
exceeding the 24% return to larger companies. Similarly, growth
outperformed value, earning 37% versus 29%. The "stuff in the
middle" that we call "Core" surprised by underperforming both value
and growth, a somewhat unusual occurrence. Our style definitions are
mutually exclusive and exhaustive, making them excellent for style
analyses, both returns-based and holdings-based. We use Surz Style
Pure® indexes throughout this commentary, as described in the
Not all style indexes are created the same. Both the S&P and
the Russell indexes disregard core. Also, the classification
variables that are used to define styles mattered a lot in 2009.
Russell uses the ratio of price to book (P/B) to divide the universe
of stocks into value and growth.* High P/B is growth and low P/B is
is that a stock trading at a price near or below its cost basis is
inexpensive, a good value. But as Laurence Siegel [Siegel, 2003]
states in a CFA Research Foundation monograph: "Book value is
mostly a historical accident. It is the accounting profession's
estimate of the company's value; it reflects what the company paid
for assets ... [and] includes the goodwill of companies
acquired." By contrast the Surz Style Pure® indexes combine
Price/Earning (P/E), dividend yield and Price/Book (P/B). The result
is that many financial companies with negative earnings and falling
prices are classified as growth by Surz but value by Russell. The
rationale for viewing stocks with negative earnings as growth is
provided in the exhibit on the right where we use the reciprocal of
P/E, also known as the earnings yield. The rationale for Price/Book
classifying troubled financials as value is that prices had fallen.
Classifying Stocks with Negative Earnings
*Russell also uses forecast earnings
growth, but the Price/Book ratio is the dominant characteristic.
The result of these differing views is shown in the next exhibit.
|2009 Style Quandary|
|Demonstrates the Importance
Classification Characteristics (P/E vs. P/B) and |
|(2) Core, the Stuff In Between Value and
All three style families agree that large growth stocks
outperformed large value, but the degree of outperformance ranges
from a 1,900 basis point spread for Russell to a 500 basis point
spread for Surz Style Pure®. These differences are caused by Surz
Style Pure®'s inclusion of core and its use of a three-factor
classification approach that views stocks with negative earnings as
growth stocks. It matters a lot which barometer you use to evaluate
performance in 2009, especially for large growth stocks.
On the sector front, every sector had gains in aggregate, but it
was certainly possible to lose money in several sectors. In the
exhibit below, we show the range of portfolio opportunities
available in each economic sector by using a simulation approach
that creates portfolios at random, selecting from stocks in each
sector. We call this approach "Portfolio Opportunity Distributions"
(PODs). As you can see in the exhibit, Information Technology was
the best performing sector for the year, earning 65.74% (middle of
the "Info Tech" floating bar), while Finance was the worst sector
with an 11.44% return. But note the ranges of the floating bars.
Financials had a lot of opportunities, i.e., a large spread in
portfolio returns, while consumer discretionary was quite narrow.
Note also how the S&P500 performed in each sector (red dot), near median in most, but
underperforming in energy, where smaller companies fared best. Note
also the sector weighting differences in the bottom of the graph.
You can use this exhibit to dissect your own performance.
Opportunities in 2009:
S&P 500 Ranked Against Total
The S&P portfolio of 500 large companies underperformed the
broad market of roughly 5,500 stocks in 2009, earning 26.5% versus
the total market's 31% return. Yes the S&P is a managed
portfolio; it's just managed by committee. A closer look is
revealing. The following exhibit shows the biggest, best and worst
stocks in the S&P during 2009. See some companies you recognize?
and Worst Stocks in the S&P 500 in 2009
Moving outside the U.S., it was possible to double your money.
Foreign markets fared much better than the U.S. in 2009, earning 45%
versus our 31%. Latin American stocks returned a sensational 108% in
the year, and every country except Japan outperformed the U.S., so
some will say that diversification "worked" in 2009, vindicating
portfolio theory. In the aftermath of the 2008 catastrophe many
lamented that diversification didn't work when you needed it most
because everything tanked at the same time. Nothing works all the
time, and diversification doesn't promise better performance, just
greater stability of returns. It is indeed a world market, and
owning more than just U.S. companies was beneficial in 2009.
|Country Returns in 2009|
The Decade of the 2000s
Annual reporting season will start soon, and this is one of those
unfortunate times when consultants and investment managers will try
to console their clients by explaining how their pain is less,
hopefully, than most others. Based on our analysis, the average U.S.
stock fund eked out a modest 0.1% per year gain during the past
decade. It was a decrepit decade.
The good news, however, is that much of the pain was limited to
just the growth sectors of the market. This will be particularly
awkward and delicate for growth stock managers, and is likely to
bring forth the difficult question about the superiority of value
investing. As for value and blend (or core) managers, they should
have delivered positive returns for the decade, with smaller value
stocks delivering double-digit returns. In other words, style
effects are extremely pronounced and important for evaluating
long-term performance. The old saw that value and growth perform
about the same over the long run does not apply to the past decade.
Similarly, there was a wide spread of country results during the
decade, with Japan losing 2.8% per year while Australia & New
Zealand delivered 20% returns.
So here's my prediction of what evaluators like Morningstar will
proclaim: growth stock managers were more skillful than value
managers during the decade because the majority of growth stock
managers outperformed their benchmarks, while the majority of value
managers lagged their benchmarks. This is poppycock caused by a peer
group flaw known as classification bias. Peer groups are terrible
backdrops for evaluating performance. That's why we provide you a
better way in the next two exhibits, which you should note are being
published here many weeks before the "real" results are
available (see the release date at the top of this commentary).
The universes in these exhibits are created using an unbiased
scientific approach called Portfolio Opportunity Distributions
(PODs). They represent all of the possible portfolios that
managers could have held when selecting stocks from the indicated
markets. Traditional peer groups are very poor barometers of success
or failure because of their myriad biases. Everyone knows that it's
easy to find a peer group provider that makes you look good, but for
some reason the industry tolerates, even condones, this deceptive
practice. For this reason, the new "Trust but Verify" is focused on
the spin rather than the accuracy of the reported return [see Surz,
2009]. As Professor Meir Statman [Statman, 2004] states in his
article entitled "What Investors Want":
money managers say they compete with other money managers by
generating the highest alpha. They denigrate the role of
marketing. Yet each money manager has ready stories about other
money managers with low alphas who snatched clients through clever
Now is the time to stop the subterfuge, because we can. PODs are
bias free and are therefore a much more reliable performance
evaluation backdrop, plus they're available now, many weeks before
the "real" biased peer groups. David Loeper, Chairman/CEO and
Founder of Finance Ware and Wealth Care Capital Management,
expresses the following consternation:
It escapes me why so many wait for biased and
inaccurate, or at least misleading, universe data when they can
get unbiased data almost immediately following any calendar
quarter or month.
You can use the charts below to get an early and accurate ranking
of your own portfolio – just plot your dot. It's our gift to you in
this holiday season.
|Pure Style Peer Groups for the Decade of the
|Pure Country Peer Groups for the Decade of
Not only did styles matter big time during the decade, style
definitions mattered as well, as shown in the exhibit on the right.
As you can see, the inclusion of "Core" serves as a significant
buffer between value and growth, so it matters how pure a manager
has been: The more pure, the more extreme the expected return.
Help Us Help You
This commentary incorporates several innovations that you can use
right now in this important annual reporting season, including:
||Surz Style Pure® Indexes (www.ppca-inc.com/SurzStyles/surz_styles.htm)|
||StokTrib holdings-based style
analysis and attribution that gets the benchmark right (http://www.ppca-inc.com/Stok_Trib/stoktrib.htm)|
Surz Style Pure® indexes are available for free on a number of
platforms including Evestment Alliance, MPI, Zephyr, Factset,
Informa, SunGard, Pertrac, Morningstar, and others. Please use them,
especially for returns-based style analysis because they meet Dr.
William F. Sharpe's recommendation to use a style palette that is
mutually exclusive (no stock is in more than one style) and
exhaustive (the collection of indexes comprise the entire market).
The good news is that Surz Style Pure® indexes are free – a free
upgrade is just mouse clicks away. Get the most out of your
returns-based style analysis investment; compare and contrast your
We've invited the service bureaus above and others to incorporate
our advanced attribution and universe approaches, and most agree
that ours are important and meaningful innovations, but there is
little business motivation for these vendors because their clients
are not requesting these services. So here's how you can help us
help you. Please ask your service providers to add these tools to
your toolbox. It costs nothing to ask, and the rewards are more
informed decision-making that will set you apart. The old tools,
namely indexes and peer groups, are incapable of performing the
basic task of separating winners from losers. And attribution
analysis that uses the wrong benchmark leads us to mistaken
inferences about the reasons for success or failure. If the
benchmark is wrong, all of the analytics are wrong, wasting our
time, energy and money.
Far worse, we make bad decisions.
These shortcomings open the door for creative salespeople to turn
mold into gold right before our eyes. The Madoff mess was made
possible by complacency and laziness in manager due diligence. (See
Please ask your service providers to add these important
innovations, and let us know how we can help you help yourself in
this endeavor. (I'm Ron@PPCA-Inc.com.)
A Word About the Old Folks
Many retirees, as well as those who are saving for retirement,
have invested in target date funds. Target date funds start out
aggressively when the target date is distant and then become more
conservative as the target date draws near. The target date fund
(TDF) industry is growing rapidly. Currently encompassing $310
Billion, this industry is forecast to grow above $2.5 trillion in
the next 10 years [see Casey, Quirk 2009], primarily because it has
become the preferred qualified default investment alternative (QDIA)
under the Pension Protection Act of 2006.
TDFs are a reasonably good idea, but suffer from pathetic
execution, at least so far. This is due in large part to the fact
that most TDFs are currently designed to serve beneficiaries beyond
the target date, to death, instead of to their presumed target – the
retirement date. Such funds have come to be known as
"THROUGH" funds, as contrasted to "TO" funds which are
designed to end at the target date. A secondary issue with
"TO" funds is the amount of equities that should be held at
the target date; we believe zero is the correct answer because
savings are most dear as retirement draws near.
2008 was disastrous for TDFs, with the typical 2010 fund losing
25%, because it held 45% in equities. 2010 funds are intended for
those retiring between 2005 and 2015. We should have learned a
lesson from 2008, but little has changed other than it is likely
that the SEC and DoL will require fuller disclosure, especially
about the meaning of the date in target date fund names. Perhaps
THROUGH funds will have to be called target
With the recovery in 2009, some have begun to argue that even
TO funds should have higher, rather than lower, equity
allocations at target date because participants will be richer. For
example, Basu  argues that a glide path that increases equity
exposure through time dominates the traditional glide path, which
has decreasing equity exposures. According to Basu, this
"Contrarian" path delivers greater ending wealth 90% of the time,
with about the same risk, leading to a characterization called
"Almost Stochastic Dominance" (ASD). ASD means the Contrarian path
is better most of the time in both risk and reward. The flaw in this
perception is that risk is measured without regard to account size,
so losing 10% of a $10 portfolio early on in the glide path is no
different than losing $100,000 on a $million portfolio as the glide
path matures. We correct this mistake in this commentary and reach a
totally different conclusion. There is no free lunch in target date
investing. After all, who would advise their clients to be entirely
in equities as they enter retirement?
An important question for fiduciaries is what are the risk and
reward trade-offs of "through versus to" TDF paths. To answer this,
we have measured ending wealth and risk for all 40-year glide paths
going back to 1926. Importantly, the risk measure is dollar-weighted
downside deviation, which we call "risk of ruin". The rationale for
this measure of risk is provided in [Surz 2009]. The following graph
on the right summarizes the results.
As you can see, the reward-to-risk is about the same for the
complete 40-year glide path, but TO funds dominate over the critical
last 10 years of the path. So now you know the risk and reward
considerations in your choice between TO and THROUGH – although both
provide roughly the same reward-to-risk profiles over the full 40
years, "TO" funds are much safer over the final 10-year period as
the target date approaches. See http://www.targetdatesolutions.com
for details on Target date Funds and fiduciary responsibilities.
Returns in 2009 were good, but it was one of only three good
years in the past decade. U.S. investors broke even on average
during this decrepit decade, unless you were concentrated in the
growth stock segment of the market, where most losses occurred. Even
though growth outperformed value in 2009, it underperformed for the
full decade, losing 8% per year while value stocks grew at 7% per
year. This will make it difficult for growth stock managers to
retain business because investors routinely confuse style with
skill, and academics assert intrinsic superiority to value
investing. It wasn't that long ago that growth stock managers
benefitted from investors' style-skill dyslexia as the growth bubble
inflated. What goes around comes around. Do not confuse style with
skill; custom benchmarks can help. Style rotation is a separate and
distinct decision from the active-passive decision.
Diversifying outside the U.S. has helped, with every country
except Japan outperforming the U.S. in the past decade. Some will
say diversification has "worked" because exposure to foreign markets
improved returns, but that is not the promise of diversification. In
theory, diversification improves the reward per unit of risk – it
smoothes out the ride.
Defined contribution plan fiduciaries have come to believe that
any target date fund will suffice because all target date funds are
qualified default investment alternatives (QDIAs). But there are
huge differences among target date funds, especially near the target
date, so this generic belief is false. Fiduciaries have the
responsibility to select and monitor good target date funds. In
particular, convenience and familiarity are foolish reasons for
entrusting employee savings to the plan's recordkeeper.
Ron Surz is
President of PPCA Inc. (www.ppca-inc.com) and its
subsidiary Target Date Solutions (www.TargetDateSolutions.com).
References Basu, Anup and Michael Drew, "Portfolio Size Effects
in Retirement Accounts: What Does it Imply for Lifecycle Asset
Allocation." Journal of Portfolio Management, April 2009.
Casey, Quirk & Associates, "Target Date Retirement Funds: The
New Defined-Contribution Battleground". November 2009 Research
Siegel, Laurence B. (2003), "Benchmarks and Investment
Management. Research Foundation of CFA Institute, Charlottesville,
Va. Available online as a free download at www.cfapubs.org/doi/
Statman, Meir, "What Do Investors Want?" Journal of Portfolio
Management, 30th Anniversary Edition 2004, pp. 153-161.
Surz, Ronald J., "Should Investors Hold More Equities Near
Retirement, or Less?" Advisor Perspectives, August 2009.
Available on line as a free download at http://www.advisorperspectives.com/.
_____________, "The New Trust but Verify". PPCA White Paper,
November 2009. Available for free download at www.ppca-inc.com/pdf/Trust-But-Verify-20091123.pdf.
APPENDIX: Surz Style Pure® Indexes
Style groupings are based on data provided by Compustat. Two
security databases are used. The U.S. database covers more than
6,000 firms, with total capitalization exceeding $18 trillion. The
non-U.S. database coverage exceeds 15,000 firms, 20 countries, and
$31 trillion – substantially broader than EAFE.
To construct style groupings, we first break the Compustat
database for the region into size groups based on market
capitalization, calculated by multiplying shares outstanding by
price per share. There are three regions maintained in our system:
U.S., Foreign and Global. Beginning with the largest capitalization
company, we add companies until 65% of the entire capitalization of
the region is covered. This group of stocks is then categorized as
"large cap" (capitalization). There are generally about 200
companies in this group for U.S., 800 for Foreign, and 1,000 for
Global. The second size group represents the next 25% of market
capitalization and is called "mid cap". There are generally about
1,000 companies in this group for U.S., 2,700 for Foreign, and 3,500
for Global. Finally, the bottom 10% is called "small cap". There are
generally 5,000 U.S. securities in this group, 10,000 Foreign and
Then, within each size group, a further breakout is made on the
basis of orientation. Value, core, and growth stock groupings within
each size category are defined by establishing an aggressiveness
measure. Aggressiveness is a proprietary measure that combines
dividend yield and price/earnings ratio. The top 40% (by count) of
stocks in aggressiveness are designated as "growth", while the
bottom 40% are called "value", with the 20% in the middle falling
So now that you know how this sausage is made, please visit the
benefits at www.ppca-inc.com/SurzStyles/surz_philosophy.htm.
Ron Surz (email@example.com)
San Clemente, CA 92673
Phone: (949) 488-8339