The Lost Decade

I’ve written about “the lost decade” before at RealMoney.  A lost decade is where  the stock market goes nowhere, or loses money for ten years.  My purpose in doing so was to point out:

  • That it is normal for lost decades to occur.  Stock returns are weakly autocorrelated.  Good years tend to be followed by good years, and bad years by bad years.
  • Once a generation, you have to get a severe boom and a severe bust.  It is partly driven by monetary policy/financial regulation laxity, followed by tightness.  It is partly driven by the fear/greed cycle, because most people, even professional investors, chase performance.
  • This has a chilling effect on retirement planning.  Recall my recent article on longevity risk.  In that article, I tried to point out the similarities for retirement investment planning between Defined Benefit plans, and an individual with his own unique retirement circumstances, typically with defined contribution plans.

I’ll amplify the last point, because the WSJ doesn’t do much with it.  Nothing kills a DB plan’s funding level worse then a protracted flat/falling equity market, and low bond yields (showing not much alternative for reinvestment).  Same for an individual financial plan.  If a DB plan has an assumed earnings yield of 8%, and the stock market earns zero, and bonds earn 5%, with 60/40 stocks/bonds, than plan earns 2% when it needs 8%.  The funding deficits grow rapidly, and corporations finally bite the bullet, and begin making contributions to their DB plan, cutting earnings in the process.

As for individuals, they should start to save more for their retirements after such a long bad market, in order to get their retirement funding back on track.  Oops, wait.  This is America.  We don’t save personally (particularly Baby Boomers), and our governments run deficits (even more on an accrual basis when we look at Medicare, Social Security, and other long-term inadequately funded programs.  Only our corporations save on net.

So, what to do?

  • Save more.
  •  Don’t materially increase or decrease allocations to stocks.  Things may be rough for a while longer, until excesses in the US financial system and in China are worked out, but positive returns will recur.
  • Avoid investing in companies with large pension funding deficits.
  • Avoid investments with high embedded leverage, whether individual companies, or ETFs.
  • Be wary of investing in esoteric asset classes this late in the performance cycle.  They may do well for a while longer, but their time is running out.  (It could be one year or another decade.)
  • Be ready for increasing inflation.  Even with the income giveup, it is probably wise to have bond durations shorter than the benchmark.
  • To the extent you can, push back retirement, or plan that you will do it in phases, where you slowly leave the formal labor force.

Of course, you could be a good stock picker, but that’s not a common gift.  The choices are hard when we have a “lost decade.”  There’s no silver bullet; only ways to mitigate the pain.