LESSONS OF THE ’90s

Do the Experts Ever Get the Future Right?

Does Anybody?

BEFORE YOU PUT ALL YOUR MONEY IN THAT TECH FUND, CONSIDER HOW FAR OFF OUR EXPECTATIONS HAVE BEEN OVER THE PAST DECADE.

SO HERE WE ARE, ONLY A FEW SCANT WEEKS INTO A NEW YEAR. A NEW DECADE, A NEW century, a new millennium. And yet plenty of people already seem certain what the future will bring: Giant U.S. growth stocks like General Electric will go right on rocking. Inflation is dead, interest rates will stay low, index funds will keep rolling. And, of course, technology stocks — especially Internet stocks — will clobber everything else in sight for years to come. In its forecast of what the market holds for the year 2000, Standard & Poor’s investment committee predicts that the S&P 500-stock index (which the committee selects but does not manage) will rise 12.6% and suggests that investors should “stick with technology and telecommunications” stocks.

At moments like these, we owe it to ourselves to take a deep breath. The ’90s are over, so let’s look back and see what the investment experts expected along the way and compare their forecasts with what actually happened.

BETTING ON JAPAN

Ten years ago, most investors — experts and amateurs alike — were as certain as they are today about what to expect. The Japanese stock market had dominated the investment scene for a decade, returning an average annual gain of 22.5%, dusting the 17.5% annual return of the U.S. market, and Japan’s blue-chip Nikkei stock index had closed 1989 at a towering record of 38,916. Japanese firms were buying such bastions of American culture as Rockefeller Center, the Pebble Beach golf resort and Hollywood’s Columbia Pictures. The early 1990s, Salomon Bros. Japanese stock analyst Christopher Mitchinson told Fortune in late 1989, “will be the golden age for Japan.” And on Jan. 2, 1990, the Wall Street Journal reported: “Even cautious observers call for the Nikkei index to end 1990 above the 45,000-point level.”

Instead, the Japanese market came down harder than a sumo wrestler, ending 1990 at 23,849 — and then kept going down for nearly the entire decade, until the Nikkei bottomed at 12,880 in October 1998.

The experts didn’t blow it just on Japan. Back in 1990, they had definitively identified the great growth industry of the future, and it wasn’t software or the Internet. (After all, technology funds had lagged the market by a gaping 3.8 percentage points a year throughout the 1980s.) It was biotechnology and health care. Then a bunch of biotech’s brave new products bombed, Hillary Clinton proposed her medical reforms in 1993 and health-care stocks have been sick ever since. Had you invested $10,000 in the average health-care fund in 1990, it would have grown to $46,500 today, whereas $10,000 invested in the S&P 500 would have grown to more than $50,000.

SUBMERGING MARKETS

The next great get-rich-quick investment? From 1991 through 1993, Morgan Stanley Capital International’s emerging markets index was hotter than a jalapeño, shooting up by 29.9% a year. By 1996, there were more than 60 emerging markets funds, up from just seven in 1992, and investors had poured $15 billion into them. But after beating the S&P 500 by an astonishing 63.2 percentage points in 1993, emerging markets funds submerged, sinking below the S&P by more than 30 points annually from 1994 through 1998. Then, in 1999 — after most experts, and many investors, gave them up for dead — emerging markets came roaring back, gaining roughly 55% for the year.

The next big idea to emerge from the crystal-ball consensus: aggressive growth funds, those baskets of little companies with big earnings boosts. These racy funds burned up the track from 1991 through 1993, beating the market by more than 12 percentage points annually. In 1996, retail investors pumped $10 billion into them, and SmartMoney magazine even recommended that “parents with young children invest 80% of college savings” in aggressive growth. Then came the dreary morning after. In 1997 and 1998, the typical aggressive growth fund lagged the S&P 500 by more than 20 points a year. Many of the hottest aggressive funds of the mid-1990s, like Founders Frontier, John Hancock Special Equities and Smith Barney Special Equities, no longer even exist.

Meanwhile, few forecasters saw the big picture any better than they saw the details. From 1990 to 1993, according to the analyst trackers at IBES International, Wall Street’s forecasts for the stock markets earnings were too high by an average of 15.6%; then, for 1994 and 1995, they were slightly too low; for 1996 through 1999, they were too high by an average of 5% annually.

Each year-end since 1995, Business Week has asked Wall Street’s top market strategists to predict the value of the Dow one year later. In 1995, they thought the Dow would hit 5430 by year-end 1996 (they were more than 1,000 points too low). For 1997, they guessed the Dow would close at 6587 (the actual number was 7908). For 1998, they reckoned the Dow would hit 8464 (they fell 717 points short). And for 1999, they said the market would finish at 9567 (this time falling short by some 1,600 points).

READING THE TEA LEAVES

All in all, the lesson of the 1990s is humbling: Nobody — neither the experts nor the amateurs among us — can read the market’s tea leaves. We’ve got no better chance of guessing the financial future than we do of guessing whether a coin-flipper is about to toss heads or tails. Thus the one indisputable lesson of the past is that the financial markets will surprise us in the future. And they will surprise most brutally the very people who are most certain about what the future holds. That’s why it’s so vital to be diversified. If tech stocks fall, a broader U.S. stock portfolio will help soften the landing. If all U.S. stocks stumble, then bonds and foreign stocks will help keep you moving forward (for more on diversification, see Sivy on Stocks, page 53). Now more than ever — with the future looking so bright thanks to the fresh polish of the past few gleaming years—it’s time to be sure you’ve spread your bets across cash, bonds, and U.S. and foreign stocks. The bet you least expect to win is the one that may very well make you the most money in the decade to come.

With additional reporting by Erica Garcia