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Another Losing Year for the Stock Market

Wall St.: Back-to-back annual losses test investors' faith in long-term returns.


A strong rally since the terrorist attacks couldn't save the U.S. stock market from recording its second consecutive losing year in 2001, a historical rarity that last occurred more than a quarter century ago.

The market's back-to-back losses in 2000 and 2001, reflecting first the bursting of the technology bubble and then the economy's slide into recession, may further challenge many investors' beliefs about the long-term appeal of stocks, experts say.

The blue-chip Standard & Poor's 500 index fell 13% last year after sliding 10% in 2000. Monday was the year's last trading day, a session that saw the market close mixed.

The last time the S&P index and other key indexes fell for two consecutive calendar years was 1973-74, during the first major energy-price shock and the Watergate political scandal.

Yet in true Wall Street fashion, both optimists and pessimists have seized upon the 2000-01 back-to-back losses to make their respective cases about the market's potential performance in 2002.

The bullish case is that a third straight year of decline would be unprecedented since World War II and therefore highly unlikely, assuming the economy recovers as most analysts expect sometime this year.

The bearish case is that, despite the market's slide since 1999, many stocks still trade at historically expensive levels relative to companies' underlying earnings potential.

In other words, the market's doubters say, the decline hasn't yet wrung out enough of the exuberance that powered the market to record highs in the late '90s. By some historical measures, critics say, such high-profile technology stocks as Cisco Systems and Yahoo are still very expensive relative to the companies' earnings.

Indeed, although two consecutive yearly losses are rare, Wall Street rode a record winning streak between 1995 and 1999: The S&P 500 index, considered the benchmark performance measure for big-name stocks, produced annual returns of more than 20% in each of those years, counting price gain as well as dividends.

That spectacular run boosted many investors' expectations for stock returns over the long term, even though Wall Street pros continually cautioned that the market's average annual gain since the mid-1920s was about 11%, and that the late 1990s were more likely to be an anomaly than the start of a new era of much higher returns.

But by early 2000, investor optimism had reached frenzied levels amid the technology stock mania. Individual investors poured record sums into stock mutual funds in the first quarter of 2000, betting that the bull market would roar ahead.

Instead, the market overall peaked in March 2000. From its record high that month, the S&P 500 is down 25%. The tech-dominated Nasdaq composite index has fared far worse: After losing 39.3% in 2000 and 21.1% last year, Nasdaq is off 61% from its peak--despite a powerful rebound since Sept. 21.

Yet many small investors believe the market is capable of resuming blistering gains over the long haul.

For example, a November survey sponsored by mutual fund giant Vanguard Group asked 500 participants in 401(k) retirement savings plans about their market return assumptions. The survey found that respondents expect the stock market to produce annual returns of about 7% over the next year or two. But the median expectation for long-term annualized returns was 15%.

Those high expectations raise the risk that more investors could become disheartened by another extended slide in stocks or by returns that are a shadow of what the market produced in the 1990s.

"As investors look to the future, they'll want to be very careful about assuming that companies can resume anything like the kind of growth rates common in the late 1990s," said Greg Smith, market strategist at Prudential Financial in New York, in a recent report to clients.

He and others say the corporate profit boom of that period was fueled by a rare confluence of events, including falling interest rates, the "peace dividend" from the end of the Cold War and the collapse of energy prices.

The stock market's performance isn't an abstract issue for many Americans: If the market falls for a third year in 2002 or fails to rally significantly in the next few years, it could change the financial outlook for many people, given the trillions of dollars invested in stocks in retirement plans and peoples' assumptions about how their wealth will grow.

A weak market also could become its own worst enemy, encouraging investors to shift money to other assets, such as real estate. That's what happened in the late 1970s: Though the S&P index surged in 1975, blue-chip stocks' performance in the late 1970s was relatively dismal, and many people turned away from stocks.

Today, Karen Huber and Nathan Rosenberg, married Orange County professionals, personify investors' mixed views of stocks.

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