A random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

THE DEVELOPMENT OF STOCK AND BOND
RETURNS (JANUARY 1982–MARCH 2000)

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This was truly an age of investor exuberance, with both
stocks and bonds producing unusually generous rates of
return. Although the nominal growth in earnings and
dividends was not any greater during this period than in the
unsatisfactory period of the 1970s, two factors contributed
to produce spectacular stock-market returns. First, initial
dividend yields of nearly 6 percent were unusually generous.
Second, market sentiment went from despair to euphoria.
Price-earnings multiples in the market more than tripled, from
8 to 30, and dividend yields fell to just over 1 percent. It was
the change in valuation that lifted stock returns from
unusually good to absolutely extraordinary.
Similarly, the initial yield of 13 percent in the bond market
guaranteed that long-term holders would achieve double-digit
returns. As I have said, what yield long-term holders see is

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what they get. In addition, interest rates fell, augmenting the
returns further. Moreover, because the inflation rate
moderated to the 3 percent level, real returns (returns after
inflation) were well above their long-term average. The 1982–
early 2000 period offered a once-in-a-lifetime opportunity to
be invested in financial assets. Meanwhile, hard assets such
as gold and oil produced negative rates of return.
ERA IV: THE AGE OF
DISENCHANTMENT
The Age of Exuberance was followed by one of the worst
decades for the stock market ever recorded. The period was
widely considered to be “the lost decade” or “the naughties.”
It was a decade most stock-market investors would prefer to
forget. The Internet bubble was followed by a crushing bear
market. Later in the decade another bubble and crash rocked
world stock markets as tumbling real estate prices destroyed
the value of the complex mortgage-backed securities that were
dependent on rising home prices. Investors were again
reminded that the world was a very risky place. Valuation
relationships changed accordingly.

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Price-earning ratios fell and dividend yields rose. The
investor who diversified her portfolio with bonds was able to
mitigate the suffering, however, as bonds produced positive
returns over the decade. The following table shows how
returns developed during the Age of Disenchantment.