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Looking Beyond the Indexes
by Craig L. Israelsen
University of Missouri-Columbia
From Financial Planning Magazine, March 2000. Reprinted with permission.
quity market indexes are helpful indicators of certain segments of the aggregate stock market. Some of the more well known equity market indexes are shown in Figure 1. Despite the fact that the year 2000 was a bust for many equity indexes (particularly those with a 'Growth' orientation) the average returns of the indexes shown below have been very encouraging. Large cap indexes (e.g. DJIA and S&P 500) have had particularly robust returns over the past 10 years. Small cap stocks, as reflected by the Ibbotson Index, have not fared as well as large caps in recent years. However, over the past 30 years the annualized return of the Ibbotson Index exceeded the S&P 500 and the DJIA.
Figure 1. Historical Returns of Major Equity Indexes
Stock Market Index
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Measures the performance of...
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Average Annual Total Return (%)
5 Years
1996 - 2000
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Average Annual Total Return (%)
10 Years
1991 - 2000
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Average Annual Total Return (%)
30 Years
1971-2000
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Dow Jones Industrial Average
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30 Huge U.S. Companies
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18.1
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17.8
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13.0
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Standard & Poor’s 500 Index
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500 of the Largest U.S. Companies
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18.3
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17.5
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13.2
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Standard & Poor’s MidCap 400
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Medium sized U.S. Companies
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20.4
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19.8
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n/a
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Ibbotson Small Company Index
(DFA US 9-10 Small Company Fund)
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Small U.S. Companies
(Smallest 20% of publicly traded stocks)
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10.9
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17.5
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14.7
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Russell 2000
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2,000 Smallest U.S. Companies
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10.3
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15.5
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n/a
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Morgan Stanley Capital International
EAFE
(Gross Index)
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Large, non- U.S. companies in Europe, Australasia, & the Far East
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7.1
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8.3
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13.0
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One must analyze the returns of indexes cautiously for at least two reasons. First, it's easy to lose sight of the long term trends when only looking at 5 to 10 year averages. This might be described as analytical short-sightedness. Second, indexes can sometimes obscure the aggregate averages of individual stock and equity fund performance.
In an attempt to address the problem of short-sightedness Figure 1 reports average returns over a 30 year period. When the period lengthens the average return is more reliable. During relatively short time frames the average returns can be volatile. For example, the 5 year return of the S&P 500 just one year ago was 28.5%. (The 5 year period from 1995-1999). Now, one year later, the 5 year annualized return from 1996 to 2000 was 18.3%. How quickly averages can shift. Clearly, shorter averages shift more dramatically from year to year.
Another technique of broadening the analytical view is examine rolling returns over periods long enough to dampen annual distortion. Such a graph is provided in Figure 2. Over the period from 1926 to 2000 there were 61 rolling 15 year periods. The 15 year average return for large stocks and small stocks is reported starting in 1940 (the first 15 year average was from 1926 to 1940). Note how small stocks, when viewed both over a long term and without annual distortion, have provided superior performance relative to large stocks. Only in recent years has the 15 year rolling return of large stock exceeded that of small stocks.
Figure 2. Rolling 15 Year Average Returns for Large and Small Stock:
1926-2000
Now, onto the second reason, that of obscured aggregate results when only looking at index returns. The most recent year provides an excellent example. The year 2000 saw the S&P 500 suffer a return of -9.1%. (FYI, the last time this popular equity index had a negative return was in 1990 when it lost 3.1%.) More broadly, the average return for the 6,090 U.S.- based stocks in the Morningstar Principia Pro database which were in existence for the full year was -5.1% (see Figure 3). The median return for stocks in 2000 was even worse at -13.8%. The best returning stock in 2000 cranked out a return of 1,786%. The worst stock (and there were many) had an annual return of -99.8%.
When the smoke cleared, 60% of all U.S. stocks suffered a negative return in 2000. The average loss was -48.2% and the median negative return was -46.5%. In many cases, it was the 4th quarter that produced the damage. However, 40% of those 6,090 stocks had a positive return. Interestingly, the average return of the 2,400+ stocks which had a non-negative return in 2000 was 58.3%. The median non-negative return in 2000 was 35.5%. An alternative perspective produces a different interpretation of the market's performance.
When examining the aggregate performance of stocks over the three year period ending 12/31/00 the story doesn't change much. The average return was -5.3%, the median return was -6.8%, and 61% of the 5,189 stocks in existence the full three years had a negative average annual return. And, if one were to consider the companies which went bankrupt during the three year period, the picture would be considerably bleaker. So, we won't consider that.
Over the past 5 years, 42% of all U.S. stocks have averaged a negative return. Moreover, the average 5 year return of those 4,211 stocks was a paltry 2.4%. This is a far different 5 year picture than the S&P 500 paints. The S&P 500 5 year average return as 18.3%. Over the 10 years from 1991 to 2000 the average return for the 2,295 stocks in existence during the entire 10 year span is a respectable 11.4%, while the median return was 11.9%. At last, results which confirm the general observation that stocks produce an average return of about 12 percent annually over the long run. However, the 10 year average return of 11.9% for aggregate stock performance is far below the 10 year average return of 17.5% for the S&P 500 and 17.5% for the Ibbotson Small Company Stock Index.
Over the ten year period from 1991-2000, the percentage of stocks which generated a negative annualized return "fell" to 20%. Nevertheless, for 20% of all stocks with a 10 year performance history to generate a negative 10 year average annual return is astonishing. Accomplishing such a feat requires a lot of losing years or several enormously bad years amidst a few decent ones.
For U.S.-based equity mutual funds (i.e. no more than 15% of the portfolio in non-U.S. stock, bonds, or cash) 2000 was no banner year either as also shown in Figure 3. The average fund produced a return of -0.3% and the median return for equity funds was -2.0%. The best performing fund had a 96.2% return in 2000 and the worst fund lost 77.3 percent. Fifty four percent of the 1,988 equity funds had a negative return in 2000. So in 2000, mutual funds provided some protection against loss in value compared to individual stocks, but not much.
The primary benefit of mutual funds, i.e. diversification, manifested itself over the 3 year period ending 12/31/00. Over that time frame only 6% of all 1,613 funds generated a negative three year average return, compared to 61% of the 5,189 individual stocks which lost money. The 3 year average return for funds was 12.6% (15.9% over 5 years and 16.6% over 10 years). Only 1% of equity funds had a negative average return over 5 years, and not even one fund produced a negative 10 year average return. (Clearly, these data do not account for funds whose pathetic performance made them candidates for a disappearing act, oftentimes being absorbed into another mutual fund within the same family). As is clearly seen in Figure 4, the average return of equity mutual funds (in the aggregate) in recent years has been much more stable, and closer to historical norms, than has been the aggregate average return of individual stocks, particularly over short time frames of 5 years or less. Accurately taking stock of equity market performance will likely require examining more than just the popular benchmark indexes.
Figure 3. Individual U.S. Stocks vs U.S. Equity Mutual Funds (as of 12/31/00)
Stocks
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1 Year 2000
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3 Years
1998-2000
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5 Years
1996-2000
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10 Years
1991-2000
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Number of Stocks in Existence During Entire Period
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6,090
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5,189
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4,211
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2,295
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Average Return (%)
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-5.1
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-5.3
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2.4
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11.4
|
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Median Return (%)
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-13.8
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-6.8
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3.6
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11.9
|
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Maximum Return (%)
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1,786.4
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662.8
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184.9
|
85.3
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Minimum Return (%)
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-99.8
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-91.7
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-80.4
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-41.5
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Number of Stocks with Negative Return
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3,625
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3,161
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1,775
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452
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Percentage of Stocks with Negative Return
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60%
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61%
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42%
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20%
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Equity Mutual Funds
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1 Year 2000
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3 Years
1998-2000
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5 Years
1996-2000
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10 Years
1991-2000
|
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Number of Equity Funds in Existence During Entire Period
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1,988
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1,613
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1,172
|
584
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Average Return (%)
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-0.3
|
12.6
|
15.9
|
16.6
|
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Median Return (%)
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-2.0
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11.6
|
16.0
|
16.4
|
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Maximum Return (%)
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96.2
|
65.7
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40.8
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34.1
|
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Minimum Return (%)
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-77.3
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-30.8
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-23.8
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.34
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Number of Funds with Negative Return (%)
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1,079
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90
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6
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0
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Percentage of Funds with Negative Return (%)
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54%
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6%
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1%
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0%
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Figure 4. Aggregate Returns for U.S. Stocks and U.S. Equity Funds
(as of 12/31/2000)
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