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Another Lost Decade in the Cards? Strategists Disagree

Plus, two Vanguard heavyweights disagree on proposed securities transaction tax.

Morningstar Analysts, 01/25/2010

There has been a lot of talk recently about the lost decade for the S&P 500. And with good reason. SPDRs SPY, the $73 billion exchange-traded fund that tracks the S&P 500, lost about 9.6% over the previous decade ending Dec. 31, 2009.

Things look even worse in real terms: If you had $10,000 in 2000, you would have needed about $12,450 at the end of 2009 just to keep up with inflation, according to the federal government. That $10,000 in the S&P would have become $9,040.

What will the next decade look like for S&P index fund investors? Does a horrible past decade of returns necessarily mean a better decade is in store?

Strategists at two prominent firms have reached different conclusions.

David Nelson, chairman of the investment policy committee at Legg Mason LM Capital Management, thinks the market as a whole is undervalued with the current fair value of the S&P 500 at roughly 1,330 based on various assumptions.

Nelson says the firm thinks the S&P could trade in the range of 1,250 to 1,350 by the end of 2010. With the S&P trading around 1,130, that means there is at least another 15% of upside remaining before hitting fair value.

That's the base-case scenario for the investment advisor that manages about $60 billion in mutual fund assets. In a best-case scenario, Nelson's estimates are much higher.

"If we assume that the worst of the financial crisis is past and that the ERP (equity risk premium) will revert to its long-term average of 4% over time, the fair-value multiple of the S&P rises to 19.3, and the implied year end 2010 target price for the S&P 500 rises to 1,472," he writes.

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