Dueling Fools
1999
December 30, 1998

1999 Bull Argument
by Bill Barker ([email protected])

Tomorrow, and tomorrow, and tomorrow,
Creeps in this petty pace from day to day,
To the last syllable of recorded time;
And all our yesterdays have lighted Fools
The way to dusty death. Out, out, brief candle!
- Macbeth

Tomorrow and tomorrow and tomorrow -- that will have us looking at the second day of our 1999 Fool-A-Day Calendars. Something about flipping through the other 363 days has Rick getting ready to panic -- and I think I know what it is. My ursine friend is no doubt going to argue that all our yesterdays over the past four or ten or seventeen years (pick a recent time frame, any time frame!) have lighted for portfolios of Fools the way to a dusty death. Rick will have us believe that after we finish going out tomorrow night, finally able after all these years to truly "Party Like It's 1999," that there soon afterwards will be a hangover to endure after the long and glorious party that we have all been enjoying for so long. "All good things must come to an end, trees don't grow to the sky -- out, out, brief candle!"

Piffle.

The grand glorious market returns that have been achieved by the S&P 500, an annualized return of 17.3% over the '90s may indeed embody a pace that there is little reason to believe can go on forever, and I expect Rick will make great use of numbers hovering around the S&P. Will it end, or at least pause, for the S&P this year? Perhaps. Who knows? Indeed, for long-term shareholders, who cares? Any argument that one should look strictly or primarily to the S&P's recent past to determine what the future holds reminds me of the only truly important event that we know will occur in 1999 -- the long-awaited release of the first chapter in the Star Wars saga, The Phantom Menace.

Yes, trotting out the recent performance of the S&P and extrapolating from that as to what will likely happen in the stock market as a whole is clearly a phantom menace, because the stock market is so much more than the five hundred biggest stocks in the market. Though the idea has taken root (and indeed this site has contributed to the notion) that the S&P 500 is the proper benchmark for the stock market and describes accurately what is going on in the stock market as a whole, this is an idea which is misleading, and obscures the truth of where the Foolish bull would most intelligently look for 1999's probable great stock ideas.

Remember small-cap stocks -- the stocks that made the Fool Ratio famous? It might be hard to remember anything about small capitalization stocks, because so few investors have been paying attention to them lately, and fewer still have actually been buying any. Small cap stocks have trailed the S&P's returns for five straight years, and in 1998 the Vanguard Small Cap Index (Ticker: NAESX) turned in about a -8% performance for shareholders. Over the last three years, small caps as a whole have turned in a 10.8% annual return, and over the last five years an 11.9% return. These results are hardly exceptional by any historic measure. Meanwhile, over the last five years, the S&P has produced an average annual return of 23.0%.

That's right, despite a booming economy, bright prospects and great execution by lots of companies in the small cap world, investors' attention of late has been focused almost exclusively on the S&P 500 in general and toward large-cap growth stocks in particular.

Does this make any real sense? Hardly. The historic returns of small caps over time match the returns of large capitalization stocks, so it doesn't take a very brave soul to predict a reversion to the mean in a big way at some point in the near future. As 1999 starts, small caps are way overdue to start seeing the types of returns that would catch them up with the narrower S&P's performance, and if anything approaching that occurs, it will be an extremely bullish market for the over 90% of companies in the market which are not in the S&P 500.

Given the returns that appear to be due to the universe of small-cap stocks, the extremely positive shape that the economy is in, and the fact that the third and fourth years of a Presidential cycle have provided superior returns over the first and second years seven out of the last eight times, 1999 is shaping up very nicely indeed.

I remember well that in early January of 1998, Rick predicted that "after a huge 3-year-run [the market] will need a December surge to squeak out a tiny 2% gain." Hey, I might have stated the same at the beginning of the year. But in evaluating whether any of us should go about trying to predict the entire market's near-term future based upon the near-term past, let us remember the closing line to Macbeth's excerpted speech from above, applicable to any editor-of-Barron's-type calls of drops in the stock market just on the basis that bad years ought to follow good ones:

It is a tale told by an idiot, full of sound and fury, signifying nothing.

Next: The Bear Argument