A Ta l e o f T h r e e Ma r k e t s —o r I s I t F o u r?

Risk and Rates of Return

© FRANK

SITEMAN/PHOTOLIBRARY

8

CHAPTER

229

The purpose of this vignette is to give you some
additional perspective on the stock market.
Refer to Figure 8-1 on page 232 as you read the
following paragraphs.
Market 1: 1975–2000. These were great years,
especially the last five. Only 3 years saw losses;
and toward the end of the run, most investors
and money managers had never experienced a
really bad market and acted as though bad mar-
kets had been banished and would never
re appear again. However, Alan Greenspan, Chair-
man of the Federal Reserve Board at that time,
knew the wild ride couldn’t continue. In 1995, he
stated that investors were exhibiting “irrational
exuberance”; but the market ignored him and
kept roaring ahead.
Market 2: 2000–2003. Greenspan was right. In
2000, the bubble started to leak and the market
fell by 10%. Then in 2001, the 9/11 terrorist
attacks on the World Trade Center knocked
stocks down another 14%. Finally, in 2002, fears
of another attack in addition to a recession led to

a gut-wrenching 24% decline. Those 3 years cost

the average investor almost 50% of his or her

beginning-of-2000 market value. People plan-

ning to retire rich and young had to rethink

those plans.

Market 3: 2003–2007. Investors had overre-

acted; so in 2003, the market rebounded, rising

by just over 25%. The market remained strong

through 2007—the economy was robust, prof-

its were rising rapidly, and the Federal Reserve

encouraged a bull market by cutting interest

rates 11 times. In 2007, the Dow Jones and

other stock averages hit all-time highs. But the

debt markets were suffering from the subprime

mortgage debacle, and institutions such as

Merrill Lynch and Citigroup were writing off

tens of billions of dollars of bad loans. Oil prices

hit $100 per barrel, gasoline prices hit new

highs, and unemployment rates were creeping

up. With this backdrop, some observers won-

dered if we were again suffering from irrational

exuberance.