MONEY

The Case for a Little Stock Market Optimism

Had you looked back in January to see how stocks did in the prior decade, you’d have been underwhelmed by annualized gains of just 3%.

Repeat that exercise today and you’ll get a decidedly brighter picture: The Dow has gained nearly 9% a year and the S&P 500 more than 8% now that the effects of the March 2000 to October 2002 bear market are more than a decade in the rearview mirror. That’s nearing the 9.8% historical average return of U.S. stocks.

No, this doesn’t erase the sting of the bursting of the tech bubble or the 2008 crash, nor does it mean you should put on rose-colored glasses as you read about 8% unemployment and a looming fiscal cliff. Nevertheless, the “lost decade” for stocks is no more.

So if the past wasn’t quite so bad, you ought to at least question the currently fashionable position that the future is really going to stink.

As governments worldwide struggle to pay down debt, the theory goes, economic activity and stock returns will be depressed for years. This is what bond guru Bill Gross and his colleagues at Pimco call “the new normal.”

Ben Inker, head of asset allocation at GMO, points out a problem with this assumption. “We don’t disagree when it comes to expectations for economic growth,” says Inker. “Where we disagree is whether the new normal has to have a bad impact on stock returns.”

Research by a team at the London Business School showing no relationship between how fast economies grow and how well stocks perform supports his view. Case in point: Since 1985, the U.S. economy grew less than a third as fast as China’s, yet American stocks gained more than twice as much as Chinese shares.

Related: Investing in China: Handle with Caution

Inker’s firm forecasts that over the next seven years, high-quality U.S. stocks should produce “real,” or inflation-adjusted, returns of 4.4% a year while foreign shares return 5%, based on factors including price/earning ratios. Again, that’s close to, though still less than, long-term averages.

Duncan Richardson, chief equity investment officer at Eaton Vance, argues the U.S. is “the most attractive major market when it comes to the fundamentals.”

What’s more, sentiment, as measured by money flowing into (or actually out of) stock funds, is as bad as it’s been in more than two decades. Most analysts believe that’s really a bullish sign.

Related: How do I make money investing?

This doesn’t mean it’s all smooth sailing ahead. Europe’s recession and China’s decelerating growth rate are cutting into U.S. corporate earnings this year. Profit growth for S&P 500 companies is expected to reaccelerate in 2013, but that assumes things don’t get worse from here.

So, yes, the risks are real, but the doom-and-gloom forecasts feel a bit overwrought.

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