Don't Expect Normal Markets in 2009

As fund managers are quick to tell us, 2008 was not a normal year. (They usually bring that up when the conversation has turned to how badly the fund has done.) There's an element of excuse-making in that, of course. "How could you expect me to perform well when conditions are so extreme?" they say, if not in exactly those words. Or, "Our process doesn't work in such abnormal environments."

It's true that some of 2008's occurrences were unprecedented. If nothing else, the government's active involvement in the fates of individual companies, with different courses taken in each case, added strange, unusual twists to the year's events. However, investors who are waiting for the markets to return to normal shouldn't hold their breath. That's not going to happen next year or anytime in the future.

I say that with confidence not because I have any special insight into the future performance of the Dow or any other index. I have no idea what will happen in the markets in 2009 or beyond. So how do I know that next year won't be normal? Because there's no such thing as normality in the investment markets.

Look at the Evidence
Just as there was no golden age when all politicians were honest and all children well-behaved, once you start looking, it's tough to find a consistently normal market climate at any time in the past. For our purposes, we can call "normal" what most people seem to be referring to when they use the phrase--essentially, an overall sense of routine in the markets, with no extremely unusual or catastrophic events shaking things up. A search through recent history finds that most periods fail to meet even that vague standard.

Most people would readily concede that the entire second half of the 1990s--which early on had Alan Greenspan already denouncing "irrational exuberance" (1996) and ended with barely existing startups commanding absurd prices--was not normal. Nor were the following few years: 2000 brought the dot-com crash, and then came 9/11 and the aftermath, which--along with the fallout from the accounting debacles at Enron, Tyco International TYC, and other firms--pushed 2001 and 2002 far into the realm of the abnormal.

No doubt some might say that the following period, from early 2003 until the current downturn, which began in the latter half of 2007, qualifies as the normal climate to which managers refer. Really? With commodity prices--and the stocks of companies involved--doubling and tripling, and then rising some more? With emerging markets (as measured by our diversified emerging-markets category) posting an annualized return of 43% from April 2003 through October 2007? One could easily argue that not a single calendar year from 1995 to the present has featured a normal market.

The longer-range picture also fits this pattern. Here we'll go with a specific, but generous, definition: We'll call a "normal" year one in which the S&P 500 rises or falls by less than 10%. Well, through 2008, Vanguard 500 Index VFINX has posted a single-digit gain or loss in only 10 of the past 30 calendar years. (One of those, believe it or not, was 2000, when the fund posted a 9.1% loss.) A situation that only occurs one third of the time can't be considered the norm.PAGEBREAK

The More Distant Past
Maybe extending the search further back in time would help. Then again, maybe not. It would be hard to find any year in the decade-and-a-half covered by the Great Depression and the global decimation of World War II that would meet anyone's definition of normal. The market frenzy that led up to the 1929 crash wasn't any more normal than the late 1990s were. Going further back, you run into another catastrophic world war and its aftermath, and in the 1890s, a deep, painful, long-lasting period of economic woe.