No Lost Decade for S&P 500 as Market Value Bias Masks Rally

By Nikolaj Gammeltoft and Lu Wang - Dec 6, 2011 4:13 AM GMT+0700

Even with the Standard & Poor’s 500 Index down 19 percent since the bursting of the technology bubble in 2000, it’s been no lost decade for stocks.

The benchmark gauge for American common equity climbed 66 percent from March 24, 2000, through Dec. 2, after stripping out adjustments for market value, which gives equal credit to Exxon Mobil Corp. (XOM), whose shares are worth $382.5 billion, and Monster Worldwide Inc. (MWW), at $945.6 million. That’s little help for most investors, whose returns reflect the capitalization-weighted index, says Cliff Asness at AQR Capital Management LLC.

Gains in the S&P 500 Equal Weighted Index through the dot- com tumble, the Sept. 11 attacks, the real-estate collapse and the worst financial crisis since the Great Depression show the resilience of U.S. companies that are forecast to report record earnings this year even as Europe’s debt crisis threatens growth again. Declines in the S&P 500’s biggest members have left them cheaper (OEX) compared with the full index than 89 percent of the time since 2000, according to data compiled by Bloomberg.

“Corporate America repaired itself,” Chris Hyzy, the New York-based chief investment officer at U.S. Trust Co., which oversees about $360 billion, said in a phone interview on Dec. 1. “On an equal-weighted basis, it hasn’t been a lost decade.”

Emergency Dollars

The S&P 500 (SPX) rose 7.4 percent last week to 1,244.28 after six central banks led by the Federal Reserve made it easier for lenders to obtain dollars in emergencies and the U.S. economy added 120,000 jobs. Bigger companies rallied more, pushing the S&P 100 Index up 7.6 percent. Both measures posted their largest gains since March 2009, the data show.

The S&P 500 climbed 1 percent to 1,257.08 at 4 p.m. in New York today, as optimism that Europe would tame its debt crisis helped the market weather a late-day selloff on reports that euro-area nations would be downgraded. The index is little changed this year.

Owners of stocks in the S&P 100 suffered the most since March 24, 2000. The index fell 33 percent, driven by declines of 70 percent or more in Cisco Systems Inc. and General Electric Co., the second- and third-largest companies behind Microsoft Corp. (MSFT) at the peak of the technology bubble.

Equities suffered two bear markets lasting longer than a year in the previous decade. The first began after the S&P 500’s price-earnings ratio reached 31.2 following the 1990s rally led by computer and software makers. The second started in 2007 as global bank losses from subprime mortgages spiraled toward $2 trillion. The gauge doubled in five years starting in October 2002 as energy companies rallied 242 percent as a group and raw- material producers jumped 162 percent.

Lehman Bankruptcy

U.S. gross domestic product has increased every year since 2000 except for the 2008-2009 period, when the bankruptcy of Lehman Brothers Holdings Inc. triggered the worst recession in seven decades. Growth is forecast to reach 2.2 percent in 2012 from 1.8 percent this year, according to the median estimate of 63 economists in a Bloomberg survey.

Energy producers climbed 149 percent in the past decade as Houston-based Southwestern Energy Co. (SWN) surged 44-fold to $37.69. Materials producers, including Cliffs Natural Resources Inc. (CLF), gained 57 percent. The Cleveland-based miner went from a split- adjusted $3.18 to $68.34.

“All you have to do is to look at the balance sheet and earnings growth, and that will show you that in general, corporate America has done very well in the past 10 years,” David Spika, who helps oversee $12 billion as an investment strategist at Westwood Holdings Group Inc. in Dallas, said in a phone interview on Dec. 1. “You are seeing a much healthier corporate America today than you saw 10 or 12 years ago.”

Record Earnings

Companies in the S&P 500 are poised to report record earnings of $99.05 a share for 2011 and profits may rise 10 percent next year and 12 percent in 2013, based on analyst forecasts compiled by Bloomberg.

The decline in the S&P 100, whose companies have an average market capitalization of $73.9 billion, has reduced valuations to 35 percent below the mean of 18.6 since 1997, data compiled by Bloomberg show. The index trades for 12.1 times reported earnings, 7.6 percent lower than the S&P 500, the data show.

Smaller companies lifted the S&P 500 Equal Weighted Index to a record on May 10, almost four years after the capitalization-based gauge reached its all-time high of 1,565.15 in October 2007.

“That cycle is running its course,” Matt Peron, a money manager at Northern Trust Corp. in Chicago, said in a telephone interview on Dec. 1. His firm manages $644 billion. “I’m not saying it’s over, but it’s getting longer in the tooth. Mega- caps are looking very cheap.”

Worse Than Bonds

The Russell 2000 Index (RTY), a gauge of small-cap shares with an average market value of $667.8 million, peaked on April 29 and is up 28 percent since March 24, 2000. Equity benchmarks did worse than corporate bonds, which returned 121 percent, according to the Bank of America Merrill Lynch U.S. Corporate & High Yield Master Index.

The relative performance of smaller stocks doesn’t help the majority of investors. More than $5.58 trillion is benchmarked to the S&P 500 and about $1.31 trillion is directly linked to its value, according to an estimate by New York-based S&P. The biggest 100 companies make up 63 percent of the value of the S&P 500 and almost half of the entire American market.

Individuals pulled $9.01 billion from equity mutual funds since March 2000, with withdrawals exceeding $27 billion each year starting in 2007, according to data compiled by Bloomberg from the Investment Company Institute, a Washington-based trade group.

Investors Weren’t Spared

Gains in the equal-weighted index reflect appreciation in its smaller companies and stocks with lower valuations over the past decade, according to Asness, who helps oversee $38.8 billion as founder and president of the AQR hedge fund in Greenwich, Connecticut. Since most investors didn’t anticipate that, they weren’t spared the lost decade, he said.

“Sorry, I’m not sure it means more than small-cap and cheap stocks had a good decade,” Asness wrote in an e-mail. “If you add us all up, we add up to cap-weighted, not equal- weighted indexes.”

Cisco (CSCO) in San Jose, California, trailed the S&P 500 in eight out of the last 11 years as the market value of the world’s biggest maker of networking equipment fell 82 percent to $99.7 billion. The stock is down 8.3 percent this year, even after posting earnings that beat analysts’ estimates for at least the 27th straight quarter.

GE (GE) Declines

The market value of Fairfield, Connecticut-based GE has dropped 67 percent. The world’s largest maker of jet engines failed to exceed analysts’ estimates for the first time in two years as third-quarter earnings suffered from tighter profit margins in the industrial business. Its shares have fallen 12 percent this year.

Microsoft, the Redmond, Washington-based software maker, has been displaced by Irving, Texas-based oil producer Exxon as the world’s biggest company after demand from emerging markets bolstered energy stocks. Exxon’s profit almost doubled in the past 11 years.

Southwestern Energy, the Houston-based natural-gas producer, earned $604.1 million last year after losing $46.7 million in 2000. Cliffs, North America’s largest iron-ore producer, has boosted earnings 56-fold since 2000 as a housing boom in China and demand from automakers boosted steel orders. Southwestern Energy has a market value of $13.1 billion, while Cliffs is worth $9.77 billion.

“It was only a lost decade if you anchored on equities as your core holding and you relied on cap-weighting,” Rob Arnott, chairman and founder of Newport Beach, California-based investment firm Research Affiliates LLC, said in a telephone interview on Nov. 18. About $78 billion is managed using his firm’s investment strategies. “It was a lost decade for most investors, but it didn’t have to be.”

To contact the reporters on this story: Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net; Lu Wang in New York at lwang8@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net