Bill Miller is one of the most closely watched money managers in the industry, so it was big news when he announced his decision last week to step down as portfolio manager of Legg Mason Capital Management Value Trust (LMVTX) early next year. His departure also adds an intriguing chapter to the long-running debate regarding the value of active stock selection.

Miller’s most frequently cited accomplishment is the fifteen-year period from 1991 through 2005, during which Value Trust outperformed the S&P 500 each calendar year, the only US equity fund manager to have ever done so. His success attracted a wide and enthusiastic following: Morningstar named him Portfolio Manager of the Decade in 1999, Barron’s included him in its All-Century Investment Team that same year, and a Fortune profile in 2006 described him as “one of the greatest investors of our time.” A former US Army intelligence officer and philosophy student, his formidable intellect covered a wide range of interests, and he believed that conventional investment analysis could be enhanced with insights drawn from literature, logic, biology, neurology, physics, and other fields not obviously related to finance. His expressed desire to “think about thinking” suggested an unusual ability to assess information differently from other market participants and arrive at a more profitable conclusion.

Miller’s bold and concentrated investment style would never be confused with a “closet index” approach. Big bets on Fannie Mae, Dell, and America Online, for example, were rewarded with handsome gains (as much as fifty times original cost in the case of Fannie Mae). Unfortunately, similar bets in recent years revealed the dangers of a concentrated strategy as heavy losses in stocks such as Bear Stearns and Eastman Kodak penalized results. For the five-year period ending December 31, 2010, LMVTX finished last among 1,187 US large cap equity funds tracked by Morningstar. Considering the enormous variation in outcomes among these carefully researched ideas, Miller’s overall investment record presents an interesting puzzle: How can we disentangle the contribution of good luck or bad luck, of skill or lack of skill?

Over the May 1982–October 2011 period, annualized return was 11.28% for the S&P 500 Index and 11.76% for the Russell 1000 Value Index. Value Trust slightly outperformed the S&P and underperformed the Russell index by over 0.40% per year. A three-factor regression analysis over the same period shows the fund underperformed its benchmark by 0.08% per month.

Do these results offer conclusive evidence of the failure of active management? Not necessarily. The fund’s expenses are above average at over 1.75% and provide a stiff headwind for any stock picker to overcome. Gross of fees, the fund’s performance over and above its benchmark goes from –0.08% to 0.07% per month. This swing from negative to positive raises an interesting point that Ken French speaks to at every Dimensional conference. There are almost certainly some mistakes in market prices and almost certainly some skillful managers who can exploit them. But who is likely to get the benefit of this knowledge—the investor with his capital or the clever money manager? If stock-picking talent is the scarce resource, economic theory suggests the lion’s share of benefits will accrue to the provider of the scarce resource—just what we see in this instance.

To cloud the discussion even further, both of these results, positive and negative, flunk the test for statistical significance; in neither case can they be attributed to anything more than chance. So even with twenty-nine years of data, we cannot find conclusive evidence of manager skill—or lack thereof. This is the inconvenient truth that every investor must confront: The time required to distinguish luck from skill is usually measured in decades, and often far exceeds the span of an entire investment career.

Miller is well aware of the challenge of distinguishing luck from skill and has conspicuously declined to boast about his results, even when they were unusually fruitful. He has acknowledged that topping the S&P 500 each year for fifteen years was an accident of the calendar and that using other twelve-month periods produced a less headline-worthy result.

Commentators have said that Miller has “lost his touch” or that his investment style is no longer suitable in the current market environment. These arguments strike us as the last refuge for those who find the idea of market equilibrium so unpalatable that they search for any explanation of his change in fortune other than the most plausible one—prices are fair enough that even the smartest students of the market cannot consistently identify mispriced securities.

Where does this leave investors seeking the best strategy to grow their savings?

When asked by a New York Times reporter in 1999 to sum up his legacy, Miller replied, “As William James would say, we can’t really draw any final conclusions about anything.” Twelve years later, this observation seems more useful than ever. And investors would be wise to treat even the most impressive claims of financial success with a healthy degree of skepticism.

Author Weston Wellington is a Vice President with Dimensional Fund Advisors

REFERENCES

Andy Serwer, “Will the Streak Be Unbroken,” Fortune, November 27, 2006.

Edward Wyatt, “To Beat the Market, Hire a Philosopher,” New York Times, January 10, 1999.

Tom Sullivan, “It’s Miller Time,” Barron’s, October 12, 2009.

Diana B. Henriques, “Legg Mason Luminary Shifts Role,” New York Times, November 18, 2011.

Standard & Poor’s

Morningstar Inc.

Anyone studying the long-run history of American business cannot help but observe how many of the prominent firms of one era fail to make it to the next. Free-market economies are characterized not only by intense competition but also by disruptive change. Sometimes a company’s toughest competitor turns out to be a firm it has never heard of selling a product or service that didn’t exist until recently. The list of companies that once dominated their industry but have fallen on hard times is lengthy enough to give every thoughtful investor reason for sober reflection.

Among many possible examples, a number of firms come to mind that were once highly regarded but later encountered serious or even fatal problems.

• Bethlehem Steel pioneered the steel I-beam, which launched a skyscraper boom in cities across the country. Its engineering expertise supplied the steel sections for the Golden Gate Bridge. But growing competition and a changing marketplace eventually took their toll, and the firm filed for bankruptcy in 2001.
• In 1973, Eastman Kodak held a seemingly impregnable position in the lucrative market for photo film and chemicals, enjoyed a reputation for innovation and astute marketing, and boasted a market value even greater than oil giant Exxon. Kodak shareholders had been favored with an uninterrupted stream of dividends dating back to 1902. Today the company is struggling to reinvent itself as the film business shrivels, the dividend has been suspended, and the share price is limping along under $3.
• A Fortune article profiling Pfizer in mid-1998 praised it for having “one of the richest product pipelines in the Fortune 500.” A Wall Street analyst enthused that “some of my clients refer to Pfizer as the best company in the S&P 500.” In early 1999, a Forbes cover story sounded a similar note, crowning Pfizer “Company of the Year” and observing that “the people who brought us Viagra have more blockbusters on the way.” Thirteen years later, the Viagra boom has subsided, patents are expiring on highly profitable products, and the gusher investors expected from the research pipeline has slowed to a trickle. The share price has slumped over 50% since year-end 1998 compared to a 3% loss for the S&P 500 Index.

Some companies almost single-handedly create new industries but still find it difficult to turn innovation into a permanent advantage. Pan Am (air travel), Kmart (discount retailing), Polaroid (instant photography), and Wang Laboratories (word processing) all had impressive initial success and provided handsome rewards for their investors. Alas, neither Pan Am nor Polaroid survives today, and Kmart shareholders were wiped out when the firm emerged from bankruptcy in 2003. (Kmart, Polaroid, and Wang Laboratories were all cited as examples of “excellent” companies in the 1982 bestseller In Search of Excellence.)

Evidence of this “creative destruction” appears all around us. For example, the Wall Street Journal reported that shares of Minnesota-based Best Buy Co. slumped Wednesday to their lowest level since 2008 after reporting a 30% drop in quarterly profits. For most of its life, Best Buy has been the toughest kid on the block, vanquishing rivals such as Highland Superstores and Circuit City on its way to becoming the nation’s leading electronics retailer.

Will Best Buy fall victim to even tougher competitors such as Amazon.com or Walmart? Or is this current downturn just a speed bump on the road to even greater success? No one can say. For every riches-to-rags story, we can find another tale of decline followed by dramatic recovery. According to some accounts, for example, Apple was only a few months from bankruptcy when Steve Jobs returned to the company in 1997. Now it vies with ExxonMobil for the number one spot in a ranking by market cap. And who would have imagined that a floundering New England textile firm with a low-margin business that sells suit-lining fabric would one day become a financial colossus known as Berkshire Hathaway?

The thrill of owning a great growth company during its most lucrative phase is a powerful incentive to search for the Next Big Thing. But almost every company with a highly profitable position is under constant attack from competitors seeking to garner a portion of those hefty profits for themselves.

As a result, the search for firms destined to generate greater-than-expected profits for many years into the future is fraught with peril and likely to end in frustration. Most investors will be far better off harnessing the forces of competitive markets and putting them to work on their behalf by holding a diversified portfolio. As Nobel laureate Merton Miller once observed, “Above-normal profits always carry with them the seeds of their own decay.”

Author Weston Wellington is a Vice President with Dimensional Fund Advisors

Miguel Bustillo and Matt Jarzemsky, “Best Buy Gets Squeezed” Wall Street Journal, September 14, 2011.

David Stipp, “Why Pfizer Is So Hot,” Fortune, May 11, 1998.

“Pfizer: Company of the Year,” Forbes, January 11, 1999.

Standard & Poor’s Stock Guide, 1974.

Thomas Peters and Robert Waterman, In Search of Excellence (HarperCollins, 1982).

Merton Miller, “Is American Corporate Governance Fatally Flawed?” Journal of Applied Corporate Finance, Vol. 6, No. 4, Winter 1994.

Last week we came across an “Economic and Policy Watch” update prepared by a major investment bank that reviewed recent government proposals to address the nation’s funding crisis. Titled “It Just Gets Worse,” the report chided policymakers for actions that “look like a poor cover for loose money, rising inflation, and fiscal problems,” and warned that “government financing needs are corrupting monetary policy.” As a result of these ill-advised tactics, the bank had turned “more negative” on the outlook for financial stability and saw “little hope of improvement in the inflation/currency mix.”

Amidst the barrage of news coverage from dozens of sources probing the US debt/default/downgrade issue, such a conclusion might seem unremarkable. We found it of interest because the focus of the report was not the US Treasury but the government of Indonesia, and it appeared over a decade ago, on July 16, 2001.

Indonesia’s sovereign debt rating at that time placed it firmly in the “junk” (non-investment grade) category: B3 from Moody’s and single-B from Standard & Poor’s. Although Moody’s upgraded Indonesia to a B2 rating in 2003 and to Ba1 in early 2011, at no time over the past decade was Indonesia deemed to merit an investment grade rating.

What has been the experience of equity investors in Indonesia since this report was published? The Jakarta Composite Index closed at 415.09 on January 16, 2001, while the Dow Jones Industrial Average finished that day at 10,652.66. On Wednesday, the Jakarta Composite closed at 4,087.09 and the Dow at 12,592.80. If the Dow Jones Average had kept pace with Indonesian stocks over the past decade, it would be over 104,000 today.

Investors in Indonesia have had their share of ups and downs over the years, and markets fell even harder than the US during the financial crisis, with a peak-to-trough loss of nearly 60%. But the recovery was sharper as well: The Jakarta Composite recouped all of its losses by April 2010, and the all-time high on July 22 this year was 45% above the high-water mark of early 2008.

For the ten-year period ending June 30, 2011, total return as computed by MSCI was 29% per year in local currency and 33% in US dollar terms. At no point throughout this period did Indonesia have an investment grade rating for its sovereign debt, and outside observers continue to find fault with the country’s troublesome level of corruption, primitive infrastructure, and unpredictable regulatory apparatus.

We are not suggesting that investors should dismiss the effects of a US government credit downgrade. US Treasury securities are so widely held around the world that any potentially destabilizing event is worrisome. Nor are we suggesting that investors focus solely on countries with low credit ratings. Just as a broadly diversified portfolio includes companies with high and low credit quality, investing in countries with both high and low ratings is equally sensible.

Some might say the strong performance of Indonesian stocks over the past decade was at least partly attributable to the nation’s improving credit profile, even if it remained at a relatively low level. The US, in contrast, appears to be deteriorating. Our point is that a low credit rating in and of itself is not necessarily a death sentence for equity investors. Citizens of triple-A countries behave much like those living in single-B territory—they eat, drink, shop, get stuck in traffic jams, chatter on mobile phones, and check their Facebook pages. (Indonesia claims the second-largest number of members in the world.) Companies doing business in either location generate cash flows, and investors do their best to evaluate what those cash flows are worth. A triple-A sovereign debt rating is no guarantee of superior equity market returns, and a “junk” rating is no assurance of failure. A diversified strategy will have exposure to both.

Author Weston Wellington is a Vice President with Dimensional Fund Advisors

Research assistance by Victoria Choi.

Ray Farris, “It Just Gets Worse,” ING Barings Economic and Policy Watch, July 16, 2001.

“Global Credit Research,” Moody’s Investors Service, March 2004.

“Missing BRIC in the Wall,” Economist, July 21, 2011.

Securities data provided by Bloomberg.

MSCI data copyright MSCI 2011, all rights reserved.

Yahoo! Finance, finance.yahoo.com (accessed July 25, 2011).

Stock prices slumped around the world yesterday [Monday, July 18], but shares of Apple Inc. shrugged off worries about a Greek government bond default and record gold prices and surged to an all-time high of $373.80. With a market value of over $344 billion, Apple has already shouldered aside Microsoft to become the world’s largest technology firm measured by market capitalization and is now second only to energy giant ExxonMobil among US stocks. It has all happened so quickly that despite its heavyweight stature in the US stock market, Apple shares are still conspicuously absent from the Dow Jones Industrial Average.

Apple’s innovative products are the gold standard for personal communication and entertainment gadgets, and the company’s fresh approach to store design generates sales-per-square-foot numbers other retailers can only dream about. As the company goes from strength to strength and the billions pile up on the balance sheet, it’s worth recalling how uninspiring the future for the company looked not so long ago.

One hundred shares purchased at the initial offering price of $22 in December 1980 have multiplied to 800 shares after four stock splits with a current market value in excess of $299,000.

Apple historical share price adjusted for splits to faciliate comparison with current $373 price.

• $39: “Lately hitting a new high above 77, stock in Apple is not just high-priced—37 times this year’s estimated profit—but high-fashion. … Apple doesn’t tempt me.” Robert Barker, “Apple: It May Be Too Late to Take a Bite,” BusinessWeek, February 14, 2005.
• $12: “But behind the hype and buzz surrounding the iPod and Jobs, there are problems stewing at Apple. Its core computer business, which still accounts for 70 percent of the company’s sales, is withering. … What’s more, despite their soaring sales, iPods are depressing profitability because of their lower profit margin.” Stephen Gandel, “Why iPod Can’t Save Apple,” Money, March 24, 2004.
• $12: “I give them two years before they’re turning out the lights on a very painful and expensive mistake.” Quotation attributed to David Goldstein, Channel Marketing Corp. Cliff Edwards, “Sorry, Steve: Here’s Why Apple Stores Won’t Work,” BusinessWeek, May 21, 2001.
• $11: “Our conclusion is that Apple has started down a path that will lead to its demise as a serious player in the PC market. … Further, we do not believe Apple will survive its next downturn, which will presage the company spiraling into insignificance as it loses any advantage of scale.” Excerpt from Dataquest company report. “Dataquest Sounds Death Knell for Apple,” Reuters, September 23, 1997.
• $4 “Apple has attracted a growing crowd of short-sellers, professional speculators who bet against a company by selling borrowed shares they hope to replace later at a profit if the stock falls. The short-sellers, in fact, now hold the equivalent of 10 percent of Apple’s shares.” Steve Lohr and John Markoff. “The Incredible Shrinking Apple Computer” New York Times, January 26, 1997.
• $6: “Apple may have few options other than to shrink the company or to eventually sell out to a deep-pocketed partner.” E.S Browning and Jim Carlton, “Apple Still Hobbled Despite Write-Down,” Wall Street Journal, March 29, 1996.

Over its thirty-plus years as a public company, Apple has turned out to be a very rewarding investment. One hundred shares purchased at the initial offering price of $22 in December 1980 have multiplied to 800 shares after four stock splits with a current market value in excess of $299,000. Over the same period, $2,200 invested in the S&P 500 with dividends reinvested grew to approximately $49,000. But how many investors would have had the patience to wait nearly three decades for their investment to bear such abundant fruit? At year-end 1985, for example, Apple shares were still stuck at $22, and by year-end 2002, they had appreciated at an annual rate of only 4.4%—well below one-month Treasury bills for a twenty-two-year period. How many of us could have stuck it out, especially with industry “experts” telling us at the time that Apple’s best days were behind it?

Some will study the ups and downs of Apple over the years and conclude that the roller coaster aspect of its business and its share price illustrates why clever timing is essential to successful investing. Our conclusion is that predicting the future is difficult and forecasting success or failure in the fast-changing world of technology is harder still. A tiny number of stocks available for trading today will produce sensational results in the years ahead. Owning a broadly diversified strategy can provide exposure to the market’s most spectacular—and unexpected—winners.

Author Weston Wellington is a Vice President with Dimensional Fund Advisors

What if you had a magic newspaper and were able to read tomorrow’s economic news today? Do you think you could successfully invest with that information?

It would make investing a lot easier, right? Well, maybe not.

Super investor Warren Buffett famously said, “If (Federal Reserve Chairman) Ben Bernanke whispered in my ear exactly what he’s going to do tomorrow, it wouldn’t change anything I’m going to do today.” The problem is it’s difficult to know how the market will interpret any given piece of information.

Take oil prices as an example. If we whispered in your ear that oil prices would fall $2 per barrel tomorrow, do you think that would be bullish or bearish for the stock market? In reality, it probably depends on the reason for the fall.

Generally speaking, falling oil prices are good for the economy because it lowers the cost of gas and may allow consumers to spend more money, which could lead to higher corporate profits. With that backdrop, if oil prices fell due to oversupply, it might be bullish for the stock market because consumers would have more money to spend.

However, if oil prices fell due to a slowing economy, some believe the stock market might sell-off because some consumers would lose their jobs and reduce spending.

So, even if you knew what was going to happen to oil prices tomorrow, you’d still need to know the “why” behind the price change to predict its impact on the stock market.

And oil is just one of many examples.

Think about the myriad of economic indicators, corporate announcements, political wrangling, regulatory actions, and other things that happen each week that could affect the stock market.

Trying to track all these factors and accurately discern their impact on the market would be futile.

“It’s déjà vu all over again.” –Yogi Berra

Let’s look back for a moment on a few flameouts from the late 1990s tech stock craze:

• The Internet community site theglobe.com set a record in November 1998 with an initial public offering (IPO) that soared 606% on its first day of trading. Despite that strong debut, it was delisted from the NASDAQ in April 2001 and today is a shell company with no significant assets or revenue.
• Pets.com (remember the “Sock Puppet?”) appeared in a Super Bowl commercial in 2000 and received $300 million in funding. It went public in February 2000 and was bankrupt just nine months later.
• The online toy seller eToys went public in 1999 and rose 280% on its first day. At its peak, the company was valued at more than $8 billion. It went bankrupt in March 2001.

Last week, we witnessed a late 1990s “déjà vu moment” with the IPO of LinkedIn, one of a new crop of social-media companies like Facebook, Groupon, and Twitter that are generating excitement among the investing public, according to MarketWatch and Barron’s. LinkedIn soared more than 100% on its opening day and finished the week with a market value of $8.8 billion, according to Bloomberg. Not bad for a company, “that doesn’t expect to be profitable this year, as it ‘invests for future growth,” according to Barron’s.

While it may be fun to marvel at the explosive debut of LinkedIn, we are not yet close to the heady days of 1999 when 308 technology companies went public, according to The New York Times. By comparison, in 2010, only 20 technology companies went public.

One of the keys to success as an investor is to pay attention and learn from the past. The stock market was “irrationally exuberant” in 1999 as evidenced by its subsequent collapse over the next three years. Is the euphoria over LinkedIn an early sign of the next “irrationally exuberant” market?

What are two things people tend to buy less of when the price goes down?

Normally, people like a bargain. When we go shopping, we feel much better buying things when they’re 20% off or “Buy one, get the second at half price.”

But, there are two things that tend to buck this trend of buying when the price goes down. If fact, with these two things, people tend to buy more of them after their price has run up. Do you have your guess on what they are?

How about real estate and stocks?

According to the most recent S&P/Case-Shiller Home Price Indices, home prices on average across the U.S. are back to their summer of 2003 level, meaning, they’re the cheapest they’ve been in about eight years.

So, are Americans clamoring to buy homes? Nope.

In February, new home sales in the U.S. fell to a record low on a seasonally adjusted annual rate, according to MarketWatch. Yet, during the boom times in 2005-2006 — when prices and sales were at their peak — people were buying homes like crazy and “flipping” them, according to the U.S. Census Bureau and Standard and Poor’s.

Likewise, when it comes to stocks, history suggests that people tend to shun them when prices are down.

For example, how many Americans were loading up the truck to buy more stocks as the market was declining to its recent low in March 2009? Not many. Yet, how many felt comfortable buying internet stocks in late 1999 as their prices were zooming?

These two examples suggest that housing and stocks are two major categories that defy traditional expectations. Knowing that, being a “contrarian” investor in these assets may be a smart long-term plan.

Bit by bit, the recovery from the traumatic stock market slump in 2008 and 2009 continues.

Although broad-market indices in the U.S. have yet to regain their previous peaks, the gap is narrowing as some industries and companies regain strength more quickly than others.

The S&P 500 Index and Dow Jones Industrial Average remain below their all-time highs by 13.4% and 10.4%, respectively, but a growing list of stocks are not only recovering but setting all-time record highs, including widely held firms such as Costco Wholesale, Cummins, Honeywell, IBM, Union Pacific and W.W. Grainger in yesterday’s trading alone [April 27th].

For small company stocks, the comeback is complete: the Russell 2000 Index established an all-time record high of 858.31 on April 27th, eclipsing its previous peak of 855.77 set on July 13, 2007. Through April 27, the index is up 150% from the darkest days of March 2009, and total return from March 2009 through February 2011 was 117.4%, the strongest 24-month period since inception of the index over thirty years ago.

We don’t know if the current strength in stock prices is an indication of even higher prices in the near future. But if recent performance reflects a so-called “new normal” pattern for the economy and the equity markets, it looks to us a lot like the “old normal”—dramatic changes in prices that confound most investors in their efforts to predict them.

Turn on the TV or the blogosphere and they’re filled with experts who make predictions about what’s going to happen in the economy or the financial markets. Generally, these experts have deep knowledge about a particular area and strong convictions in their forecasts and predictions.

Unfortunately, their accuracy is no better than dart-throwing monkeys, according to Philip Tetlock, a professor at UC Berkeley and author of the 2005 book, Expert Political Judgment: How Good Is It? How Can We Know?Tetlock conducted a long-term study of 284 experts who made their living “commenting or offering advice on political and economic trends.” Over the course of two decades, he tracked the accuracy of the 82,361 forecasts made by these experts.

The results are startling.

Here are some of the highlights as reported in an article by Louis Menand in The New Yorker:

• The better known and more frequently quoted an expert is, the less reliable their guesses about the future are likely to be.
• People who stay up-to-date on current events through regular reading and watching the news can guess what is likely to happen about as accurately as the experts quoted in the papers and on the news shows.
• Experts tend to fall in love with their ideas and display a double standard, i.e., they accept information that supports their position much more easily than information that contradicts their position.
• After the fact, experts tend to claim a higher degree of accurate forecasting than they actually achieved.

While experts may not be so “expert” after all, there is hope. Tetlock discovered that when it comes to making predictions, it’s better to know a little about a lot than a lot about a little.

He said people who had a broad understanding about many things tended to be more flexible and willing to stitch together diverse information to reach an opinion.

By contrast, experts tended to try and expand their deep expertise in one area into other areas that were not really relevant.

The New Normal.

By now, you have probably read that you should prepare yourself for a New Normal in the stock market. The 2008 global market crisis and the struggling economy have left many investors fatigued. Despite two years of strong equity returns, some investors have been slow to regain market confidence. And by now, many are accepting the talk about a “new normal” in which stocks offer lower returns in the future.

The concept of a new normal is anything but new. In fact, throughout modern history, periods of economic upheaval and market volatility have led people to assume that life had somehow changed and that new economic rules or an expanding government would limit growth. What they could not see was how markets naturally adapt to major social and economic shifts, leading to new wealth creation.

Let’s look at other periods when investors had strong reasons to give up on stocks, and consider the parallels to today:

1932: The US stock market had just experienced four consecutive years of negative returns. A 1929 dollar invested in stocks was worth only 31 cents by the end of 1932. Hopes were sinking during the Great Depression, and many people felt as though the economy had permanently changed. Many investors left the market, and some would not return for a generation. Amidst what is considered the roughest economic time in US history, the markets looked ahead to recovery.

US Stock Market Performance after 1932*
Annualized
5 Years: 15.35% – Growth of $1: $2.04
10 Years: 10.07% – Growth of $1: $2.61
20 Years: 13.19% – Growth of $1: $11.92

All stock market returns based on CRSP 1-10 index.

*Past performance is no guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

1941: World War II was raging, and the US had just entered the conflict. The US stock market had experienced two consecutive years of negative performance, and the economy had shown signs of sliding back into depression. Although conversion to a wartime economy would revive industrial production and boost employment, investors struggled to see beyond the conflict. Many expected rationing, price controls, directed production, and other government measures to limit private sector performance.

US Stock Market Performance after 1941*
Annualized
5 Years: 18.63% – Growth of $1: $2.35
10 Years: 16.67% – Growth of $1: $4.67
20 Years: 16.29% – Growth of $1: $20.47

1974: Investors had just experienced the worst two-year market decline since the early 1930s, and the economy was entering its second year of recession. The Middle East war had triggered the Arab oil embargo in late 1973, which drove crude oil prices to record levels and resulted in price controls and gas lines. Consumers feared that other shortages would develop. President Nixon had resigned from office in August over the Watergate scandal. Annual inflation in 1974 averaged 11%, and with mortgage rates at 10%, the housing market was experiencing its worst slump in decades. With prices and unemployment rising, consumer confidence was weak and many economists were predicting another depression.

US Stock Market Performance after 1974*
Annualized
5 Years: 17.29% – Growth of $1: $2.22
10 Years: 15.92% – Growth of $1: $4.38
20 Years: 14.89% – Growth of $1: $16.07
5 Years 10 Years 20 Years

1981: The stock market had delivered strong positive returns in five of the last seven calendar years, and the two negative years (1977 and 1981) were only moderately negative. Despite these results, investors were weary from stagflation, which was characterized by high annual inflation, anemic GDP growth, and unemployment, and from fears of another economic downturn. In late 1980, gold climbed to a record $873 per ounce—or $2,457 in 2010 dollars. (By comparison, spot gold reached $1,256 per ounce in 2010.) Memories of the 1973–74 bear market lingered. A 1979 BusinessWeek cover story titled “The Death of Equities” claimed inflation was destroying the stock market and that stocks were no longer a good long-term investment.

US Stock Market Performance after 1981*
Annualized
5 Years: 18.82% – Growth of $1: $2.37
10 Years: 16.58% – Growth of $1: $4.64
20 Years: 14.54% – Growth of $1: $15.11

1987: On “Black Monday” (October 19, 1987), the Dow Jones Industrial Average plummeted 508 points, losing over 22% of its value during the worst single day in market history. The plunge marked the end of a five-year bull market. But in the wake of the crash, the market began a relatively steady climb and recovered within two years. The effects of the crash were mostly limited to the financial sector, but the event shook investor confidence and raised concerns that destabilized markets would increase the odds of recession.

US Stock Market Performance after 1987*
Annualized
5 Years: 16.16% – Growth of $1: $2.11
10 Years: 17.75% – Growth of $1: $5.12
20 Years: 11.89% – Growth of $1: $9.46

2002: By the end of 2002, investors had experienced the stress of the dot-com crash in March 2000, the shock of the September 11 attacks, and the early stages of wars in Afghanistan and Iraq. Although October 9, 2002, would ultimately mark the market’s low point, investors had endured three years of negative performance and an estimated $5 trillion in lost market value. A younger generation of investors had experienced its first taste of old-world risk in the “new economy.”

US Stock Market Performance after 2002*
Annualized
5 Years: 13.84% – Growth of $1: $1.91
10 Years: - – Growth of $1: -
20 Years: – - Growth of $1: -

2008–Today: The market slide that began in 2008 reversed in February 2009—gaining 83.3% from March 2009 through 2010. Despite two years of strong stock market returns, memories of the 2008 bear market and talk of the “lost decade” have led many investors to question stocks as a long-term investment. But earlier generations of investors faced similar worries—and today’s headlines echo the past with stories about government spending, surging inflation, deflationary threats, rising oil prices, economic stagnation, high unemployment, and market volatility.

Of course, no one knows what the future holds, which brings the concept of “normal” into question. What exactly is the status quo in the markets?

Since 1926, there have been only four periods when the stock market had two or more consecutive years of negative returns. In addition, annual returns are rarely in line with the market’s 9.67% long-term average (annualized). The most obvious normal may be that, over time, stocks offer expected returns reflecting the uncertainty and risk that investors must bear.

What’s new about that?