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Commentary by Chet Currier

As stocks struggled through an ugly bear market a few years back, something wonderful happened to serve the cause of investors.

The Smart Money declared that assets of all types -- bonds and money markets as well as stocks -- were embarking on a new era of low returns stretching out as far as the eye could see.

The 1980s and '90s had produced outsized payoffs for both stock and bond investors as inflation and interest rates came down. In the aftermath of that runaway bull market, "the hangover may prove to be proportional to the binge," wrote the most revered investor of them all, Warren Buffett, in his 2002 letter to shareholders of Berkshire Hathaway Inc.

Books were written, seminars convened on the subject of how to invest in "a low-return world." The new thinking gave a nice boost to hedge funds, sophisticated partnerships that could play the markets from any side and weren't dependent on a general rise in security prices to achieve their hoped-for results.

The whole idea was no idle hypothesis. It made plenty of sense to anyone who believed markets were subject to the iron mathematics of mean regression -- that sooner or later all excesses in one direction must be corrected by swings the other way.

It also looked persuasive to anyone who could examine an interest-rate chart. The yield on 10-year Treasury notes had fallen from 14 percent in the early 1980s to 4 percent in the early '00s, giving both stock and bond prices a powerful lift. There was no way anything like that could happen again.


In short, the low return hypothesis was the height of wisdom and prudence. So the word was passed, from strategist from analyst, from fund manager to fund shareowner, from financial planner to customer.

And in the lovely, oh-so-unscientific way markets have of absorbing truths of all kinds, expectations came down. The more subdued the view everybody took of investment possibilities, the more room opened up for whatever surprises came along to be positive, not negative. Stocks, in particular, had a good, solid "wall of worry" to climb.

In the last five years through the middle of this week, the average return among all 4,000-plus U.S. stock mutual funds tracked by Bloomberg was 10.3 percent a year including dividends -- just about normal, by usual standards. Among 2,000-plus bond funds, the average payoff has been 5.2 percent, which also is right around the historical norm.

In 2006, according to researcher Ibbotson Associates, small stocks returned 16.2 percent, and big stocks 15.8 percent. Both those gains surpassed the historical averages, calculated back 81 years, of 12.7 percent for small stocks and 10.4 percent for large.


By any standard, 2006 was an angst-ridden year. The war in Iraq went badly, commodity markets behaved feverishly, inflation worries alternated with recession fears, and investors even found time to fret about hurricanes that never materialized. Stock market gains came grudgingly -- but they came.

This strongly suggested that the low-return hypothesis remained in effect. No sooner were some bullish voices raised at yearend about prospects for 2007 than a chorus of naysayers arose to protest that optimism was running riot.

Maybe so. The fact is, we don't know yet whether the bulls or bears are right about the year ahead. Quite possibly the markets will figure out a way to prove both sides wrong. This isn't to say, however, that we can't learn anything from the experience of the past few years.

We are quite justified in concluding that the smartest, best-informed people in the world can't predict the next decade in the markets any better than they can predict the next day or the next month.


Because of the natural tendency for economies to grow, the odds favoring a bullish forecast presumably improve as the time covered by the forecast increases. But when it comes down to details such as how large or how little a gain is likely to be, it's every investor for himself.

That leaves history as the best available, if highly imperfect, guide. By my scratch-paper calculations from the Ibbotson statistics, a simple buy-and-hold investor who owned large stocks, small stocks, government bonds and short-term Treasury bills in equal 25 percent allocations over the last 81 years would have earned just a shade more than 8 percent a year on his money.

Inflation ran at 3 percent, according to Ibbotson. That left a generous 5 percent a year in real return for the investor to share with the tax collector. In the absence of any reliable way to foresee the future, that's a pretty nifty performance. It's never guaranteed, of course, but the record shows it's possible --even when you are living in what has been officially certified as an era of low returns.

(Chet Currier is a Bloomberg News columnist. The opinions expressed are his own.)

--Editor: Greiff

To contact the editor responsible for this column: James Greiff at +1-212-617-5801 or jgreiffbloomberg.net

-0- Jan/19/2007 16:33 GMT