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The 2000–2013 Lost Decade
Thirteen years. Two cyclical bears averaging over fifty percent. The index ended below where it started.
By March 2000 the United States had been in continuous economic expansion for 118 months, the longest sustained expansion in American history. The Federal Reserve under Alan Greenspan had engineered a soft landing from the 1994 overheat, caught the 1998 LTCM failure before it mattered, and let the dot-com bubble inflate to a Shiller CAPE of forty-four, the highest valuation ever reached by the US equity market. Forty percent of the Nasdaq had no earnings. Price-to-sales multiples on companies named Pets.com and eToys exceeded fifty. The retail investor had been taught that stocks always come back.
The next thirteen years would challenge every assumption built in the preceding eighteen. The S&P 500 would fall forty-nine percent in a two-and-a-half-year dot-com bust, recover for five years in a housing-and-credit boom that could not possibly end well, then fall fifty-seven percent in a global financial crisis so severe that the Federal Reserve would effectively guarantee every money-market fund in the United States and acquire four trillion dollars of long-dated Treasuries and mortgage-backed securities. Investment banks that had stood since the Civil War would disappear in a week. The U.S. government would take eighty percent of AIG and the senior claim on Citigroup and General Motors.
And when it was over, the S&P 500 would be below where it started. From 1,527.46 on March 24, 2000 to 1,569.19 on March 28, 2013. Thirteen years, forty-two points, before inflation. In real terms, equity capital lost about one percent a year. The index would then launch the AI-and-passive-flows secular bull that is still running today, the subject of our final chapter.
Numbered bands mark each cyclical phase; the sections below walk them in order. On measurement: we use the S&P 500 throughout this series rather than the Dow Jones Industrial Average. The S&P samples five hundred companies against the Dow’s thirty; it is the only common ruler that spans every secular era from 1929 to today.
1
▼ CYCLICAL BEAR
The Dot-Com Bust
Thirty-one months. Minus forty-nine percent. The deepest cyclical bear since 1974.
On March 10, 2000, the Nasdaq Composite closed at 5,048.62. On March 24, the S&P 500 closed at 1,527.46. Both would be the all-time highs for the next seven and five years respectively. The valuation starting point was unprecedented: the Shiller cyclically-adjusted P/E ratio stood at forty-four, higher than it had been at the 1929 peak. Forty percent of Nasdaq-listed companies had no earnings at all. Price-to-sales ratios on companies named Pets.com, eToys, and Theglobe.com exceeded fifty. Day-trading had become a mass phenomenon; retail investors had been borrowing on margin to buy IPOs they intended to flip in hours. On April 14, 2000, the Nasdaq fell 9.7 percent in a single session as mutual-fund redemptions, tax-driven profit-taking, and the first serious internet-sector bankruptcies collided. The dam broke.
On September 11, 2001, nineteen hijackers flew four commercial aircraft into the World Trade Center, the Pentagon, and a Pennsylvania field. The New York Stock Exchange closed for four trading days, the longest closure since the Depression, and reopened on September 17 to a seven-percent decline. By September 21 the market was down fourteen percent for the week. The United States was at war within a month, in Afghanistan on October 7, and the economy was in a mild recession that would be deepened by a wave of corporate accounting scandals: Enron bankrupt on December 2, 2001; Arthur Andersen indicted March 14, 2002; WorldCom bankrupt July 21, 2002 (surpassing Enron as the largest corporate failure in US history until Lehman); Sarbanes-Oxley signed July 30, 2002 to attempt a legislative response.
The S&P 500 made its final low on October 9, 2002 at 776.76, down forty-nine percent from the March 2000 peak, the deepest cyclical bear since 1974. The Nasdaq Composite lost seventy-eight percent peak-to-trough. Three-point-eight trillion dollars of American household wealth had been eliminated. The Federal Reserve under Alan Greenspan, which had been raising rates during 1999-2000 to deflate the bubble, had reversed course sharply in January 2001 and would continue cutting until the federal funds rate reached one percent in June 2003, the lowest level since 1958.
The one-percent federal funds rate, held there for a year, would set up what came next.
“Forty percent of Nasdaq-listed companies had no earnings at all.”
2
▲ CYCLICAL BULL
The Housing Boom
Sixty months. +102%. Cheap money, Iraq, and a housing market that forgot it could go down.
On March 19, 2003, the United States invaded Iraq. The “shock and awe” air campaign that opened the war was broadcast live on CNN; the market was up 2.3 percent that session. The removal of Saddam Hussein, achieved in forty-two days of major combat, was followed by eight years of insurgency, four thousand four hundred American military deaths, and a reconstruction that cost the U.S. Treasury over a trillion dollars. The economy, however, boomed. The combination of Bush’s 2003 tax cuts (which took the dividend and capital-gains rate to fifteen percent) and the Federal Reserve’s one-percent federal funds rate (held there from June 2003 to June 2004) ignited the single greatest housing cycle in American history. Thirty-year mortgage rates fell to five percent. Home prices nationally rose fifty percent between 2003 and 2006. In some markets, Las Vegas, Phoenix, Miami, Orlando, inland California, prices doubled.
The underlying mechanics were being distorted at the same time. Subprime mortgage origination grew from six percent of new mortgages in 2001 to twenty-four percent by 2006. The loans were packaged by Wall Street into mortgage-backed securities, re-sliced into collateralized debt obligations rated AAA by Moody’s and S&P on the strength of statistical correlation models that assumed home prices could not fall nationally, and sold to banks and pension funds worldwide. Credit-default swaps on the whole structure were being written by AIG without reserves. On May 31, 2006, Alan Greenspan retired after eighteen years as Fed chair and was replaced by Ben Bernanke, an academic specialist in the Great Depression who would within thirty months find himself fighting it in real time.
The S&P 500 ran from 776.76 to 1,565.15 over sixty months, a 102 percent gain, finally reclaiming the March 2000 peak in October 2007. The Dow Jones Industrial Average crossed 14,000. On July 31, 2007, three months before the market would peak, two Bear Stearns hedge funds specializing in mortgage-backed securities announced they were worth zero. The first visible crack. By October the credit markets were beginning to seize. On October 9, 2007, the S&P 500 reached its peak at 1,565.15. Nobody at the time understood what was already underway.
What was underway was the largest financial crisis since 1929.
“Credit-default swaps on the whole structure were being written by AIG without reserves.”
3
▼ CYCLICAL BEAR
The Great Financial Crisis
Seventeen months. Minus fifty-seven percent. The deepest cyclical bear since 1932.
The cascade began slowly. On January 11, 2008, Countrywide Financial, the nation’s largest mortgage originator, was sold to Bank of America for $4 billion, roughly a tenth of its 2006 peak market cap. On March 16, 2008, Bear Stearns, the fifth-largest American investment bank, founded in 1923, was sold to JPMorgan Chase for two dollars a share in a Federal Reserve-brokered weekend deal that included a $29 billion Treasury guarantee against the losses on its mortgage portfolio. The investment-banking industry had thought Bear Stearns too interconnected to fail; its disappearance meant nothing was too interconnected to fail. On July 11, 2008, IndyMac Bank was seized by federal regulators, the second-largest bank failure in American history. On September 7, 2008, the U.S. government placed Fannie Mae and Freddie Mac into conservatorship, assuming responsibility for $5.4 trillion of mortgage obligations.
On September 15, 2008, Lehman Brothers filed for Chapter 11 bankruptcy with a $691 billion balance sheet, the largest bankruptcy in American history. The following morning the money-market fund Reserve Primary, which held $785 million of Lehman commercial paper, broke the buck, trading below one dollar per share for the first time since 1994. By Monday morning the shadow banking system was in open run. On September 16, the Federal Reserve lent AIG $85 billion in exchange for an 80 percent equity stake, averting the counterparty cascade that would have followed AIG’s collapse on its $441 billion of credit-default-swap writing. On September 19, Treasury Secretary Henry Paulson announced TARP, a $700 billion program that passed Congress on October 3 after an initial rejection that cost the Dow 777 points in a single session. On October 14, Paulson summoned the CEOs of the nine largest American banks to the Treasury and informed them that each would accept a capital injection from the United States government whether they wanted it or not.
On November 4, 2008, Barack Obama was elected the forty-fourth president. On November 25, the Federal Reserve announced it would purchase six hundred billion dollars of agency mortgage-backed securities, the first phase of what would be called quantitative easing. On March 9, 2009, the S&P 500 reached its final low at 676.53, down fifty-seven percent from the October 2007 peak, the second-deepest cyclical bear since 1932. Household net worth had fallen by eleven trillion dollars. Nine million jobs had been lost. The unemployment rate reached ten percent in October 2009. Three-and-a-half million homes were in foreclosure. The architecture of American finance had been rewritten in six months.
And then, on the following morning, the market began the single greatest rally in modern American history.
“Paulson summoned the CEOs of the nine largest American banks to the Treasury and informed them that each would accept a capital injection from the United States government whether they wanted it or not.”
4
▲ CYCLICAL BULL
QE and Recovery
Twenty-five months. +102%. The Fed buys everything that isn’t nailed down, and the market reflects.
On March 10, 2009, the day after the GFC low, Citigroup, which had received forty-five billion dollars in TARP capital and whose stock had traded below one dollar, announced that it had been profitable in January and February. The market rallied six percent. On April 2, the G20 London summit committed to a one-trillion-dollar coordinated global stimulus. Through 2009 the Federal Reserve’s balance sheet grew from nine hundred billion to over two trillion dollars, purchased assets replacing panicked money-market deposits as the liability-side funding for every major American bank. By June 2010, QE1 was complete and the economy had technically exited recession. Unemployment peaked in October 2009 at ten percent, began to decline, and would spend the next five years grinding slowly back down.
On March 23, 2010, Obama signed the Affordable Care Act, the most consequential expansion of the American social safety net since Medicare in 1965. On April 20, 2010, the BP-operated Deepwater Horizon drilling rig exploded in the Gulf of Mexico, killing eleven workers and discharging 4.9 million barrels of crude oil over the following 87 days, the largest marine oil spill in history. On May 6, 2010, the Dow Jones Industrial Average fell nine hundred points in fifteen minutes and recovered six hundred of them twenty minutes later. The “Flash Crash” was traced to a mutual-fund algorithmic sell order that was executed too fast for the market’s then-existing circuit breakers to absorb, and introduced retail investors to the fact that most of the trading in American equities was now being done by high-frequency algorithms running on co-located servers at the exchanges. On November 3, 2010, the Fed announced QE2, another six hundred billion dollars of Treasury purchases, and the market ran straight through year-end.
The S&P 500 rallied from 676.53 to 1,363.61 over twenty-five months, a 102 percent gain, matching the 2002-07 recovery almost exactly. On May 2, 2011, a SEAL Team Six raid in Abbottabad, Pakistan killed Osama bin Laden, providing symbolic closure to the ten-year post-9/11 era just as the next crisis was arriving. On March 11, 2011 the Fukushima disaster had already paralyzed the Japanese economy and caused the global nuclear industry to be effectively frozen for a generation; by April the Arab Spring had toppled Mubarak in Egypt, was in the process of toppling Qaddafi in Libya, and had begun a Syrian civil war that would last the rest of the decade. The market peaked on April 29, 2011, exactly where the previous crisis was waiting to arrive from.
That crisis was in southern Europe, and it had the potential to blow up the euro.
“The Flash Crash introduced retail investors to the fact that most of the trading in American equities was now being done by high-frequency algorithms running on co-located servers at the exchanges.”
5
▼ CYCLICAL BEAR
The Euro Debt Crisis
Six months. Minus nineteen percent. The last cyclical bear of the Lost Decade.
Greek government bond yields had been rising since early 2010 as markets realized the official debt-to-GDP statistics had been understated for a decade. By July 2011 the Greek two-year yield was over thirty percent. On July 21, 2011, euro-zone finance ministers approved a second Greek bailout totaling €109 billion, including the first forced haircut on private holders of a developed-market sovereign bond since the 1930s. The precedent set, that European sovereign debt was not actually free of credit risk, triggered sympathy selling across the periphery. Spanish and Italian ten-year yields rose above seven percent, levels at which refinancing becomes impossible. The question for the first time was not whether Greece would leave the euro, but whether Italy and Spain, the third and fourth largest euro-zone economies, would.
On August 5, 2011, in the middle of the crisis, Standard & Poor’s cut the United States sovereign credit rating from AAA to AA+. It was the first downgrade of American sovereign debt in the history of the rating. The immediate trigger was the political dysfunction of the July 2011 debt-ceiling standoff, in which House Republicans had come within ninety-six hours of forcing the United States Treasury to miss a debt payment. The following Monday, August 8, 2011, the Dow Jones Industrial Average fell 634 points, nearly six percent, in a single session. The S&P 500 would fall seventeen percent peak-to-trough over the two months that followed.
The policy response came in two parts. On September 21, 2011, the Federal Reserve announced “Operation Twist”, the sale of $400 billion of short-term Treasury holdings and the purchase of equal volume at the long end, intended to flatten the yield curve and support housing. On December 21, 2011, the European Central Bank announced the first Long-Term Refinancing Operation, three-year loans to euro-zone commercial banks at one percent, which the banks used to buy their own sovereign bonds. By mid-2012, when ECB President Mario Draghi delivered his famous “whatever it takes” speech in London on July 26, the acute phase of the euro crisis was over. The S&P 500 made its interim low at 1,099.23 on October 3, 2011, and began climbing.
Over the next seventeen months the index would climb thirty percent and finally reclaim the March 2000 peak. The thirteen-year Lost Decade was over.
“The question for the first time was not whether Greece would leave the euro, but whether Italy and Spain, the third and fourth largest euro-zone economies, would.”
Thirteen years. Zero nominal return. The deepest cyclical bear since 1932, and the greatest central-bank intervention in American history.
The 2000-2013 Lost Decade was the economic consequence of two valuation bubbles that burst in opposite ends of the asset-price spectrum: a 1999 technology-stock bubble followed by a 2006 residential-real-estate bubble. The common cause was the same one that had driven the Great Moderation: twenty years of falling interest rates and institutional confidence in Federal Reserve crisis-management had taught every allocator of capital that risk assets would be caught before they fell. When the Fed itself failed to catch the fall, because the leverage inside the housing-finance system was too large for conventional monetary policy to offset, the Fed invented a new tool. Quantitative easing was the policy innovation of the Lost Decade. The resulting four-trillion-dollar Federal Reserve balance sheet is the inheritance every asset class has traded against since.
Investors who held the index through the full thirteen years earned close to zero in nominal terms and about negative one percent a year in real terms. Investors who sold at the 2002 low or the 2009 low earned catastrophically negative returns. Investors who rebalanced systematically through the two drawdowns earned closer to seven percent a year in real terms, the best outcome available in a secular bear is to buy the drawdowns.
The lesson of the Lost Decade is that two sequential cyclical bears of over fifty percent, bookending a cyclical bull of over a hundred percent, is the exact pattern you should expect inside any secular bear. It happened in 1929-1949. It happened in 1966-1982. It happened in 2000-2013. Pattern-recognition investors earned the best returns in each. Trend-following investors earned the worst.
The AI & Passive Revolution
On March 28, 2013, the S&P 500 finally reclaimed its March 2000 peak at 1,569.19, thirteen years late and in dollars that had lost 36 percent of their purchasing power in the interim. The reclaim was quiet. Nobody rang a bell.
What has followed is the current secular bull. It has run through the Trump tax cuts, the COVID crash and recovery, the 2022 rate-hike cycle, the regional bank failures of 2023, and the AI investment wave that has concentrated more market capitalization in fewer companies than at any point since the Great Depression. Interest rates have risen from zero to five and back to three. The index has roughly quadrupled. Price-to-earnings multiples have expanded from fifteen to thirty.
Where does this bull end? That is a separate conversation, the one happening on every secular dashboard this site publishes. For the historical arc, we close here.
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