Will the Bull Market Keep Stampeding?

The past quarter century has been a sizzling time for the American stock market. As the United States assumed the position of the world's singular superpower, its economic machine powered forward, providing investors in all asset classes with handsome returns.

From November 1982 to September 2007, the S&P 500 index dished out an annualized return of 13.6 percent, for a cumulative yield of 2,346.6 percent. Small-cap stocks did nearly as well, returning 12.1 percent a year, or 1,618 percent cumulatively. Even bonds got in on the good times thanks to the big drop in inflation, with the Lehman Brothers Bond Index producing 8.76 percent annualized returns. "We certainly have been in a bull market since the 1982 time frame," says Conrad Herrmann, a portfolio manager at Franklin Templeton Investments.

But as investors prepare for the next 25 years, they confront a much different economic landscape. "You have to be realistic," says John Silvia, Wachovia's chief economist. "Our position in the global economy was very unusual post-World War II and after the fall of the Berlin Wall, but the structural nature of the global economy has changed."

Explosive growth in emerging markets—particularly China—is at the root of this changing world economy. The World Bank estimates that China's gross domestic product more than tripled from 1996 to 2006, growing at an average of 9 percent a year.

Michael Metz, the chief investment strategist at Oppenheimer, sees such emerging nations as a threat to the American economy. He argues that countries like India and China will begin siphoning off high-value-added jobs—from the information technology, financial services, accounting, legal, and medical sectors—in much the same way they have already swallowed lower-level manufacturing positions. "[India and China] appear to be going after all of the lush parts of the economy, and I don't see how they can be stopped," Metz says. "I just think the American era is over."

Observers see domestic threats to U.S. growth as well. Social Security and healthcare costs, for instance, could result in government taking a much bigger share of the economic pie. "In terms of taxes, regulation, and inflation, we are probably not going to do as well in the next 25 years as we did in the first 25 years," Silvia says.

But by no means is everyone so downbeat about the 25-year outlook. Fritz Meyer, a senior market strategist at AIM Investments, expects the continued growth of the American working population to help the U.S. stocks remain competitive. "Decade in, decade out, U.S. equities have delivered approximately 10 percent annually," Meyer says. "I don't see that changing, which would make U.S. equities a pretty darned attractive place to invest."

Jonathan Golub, the chief investment strategist at Bear Stearns, agrees, arguing that China's rise alone does not signal America's doom. "Sure it's scary, but I don't see why that should prevent our success," Golub says. "While they might grow faster than us, that doesn't mean that our standard of living and quality of life and economic success won't be substantially higher than it is today."

Duncan Richardson, the chief equity investment officer at Eaton Vance, says that although the U.S. equity market may not be able to match its returns from the previous 25 years, it will remain vibrant and profitable in the future. "It's been a remarkable 25 years, so I don't think those levels [of returns] will be achieved," Richardson says. "But I do think that in comparison to all asset classes, [the U.S. equity market] will return a premium."

While the outlook for the next quarter century may have divided market prognosticators into bears and bulls, observers agree on one way that all investors can better position themselves for future success: buy more foreign equities.

"In these emerging markets, the per capita incomes are going to rise, and they are going to rise fast," says Jeffrey Saut, the chief investment strategist at Raymond James. "I think that the outsized growth—the strongest growth—will be from the emerging markets." Saut expects such growth to include not just China but India, Brazil, Thailand, Vietnam, Malaysia, and Uzbekistan. "This is a trend I think you can play for the next 20 years," he adds.

Meyer agrees, arguing that "Americans are still woefully underexposed to foreign stocks." So how much foreign exposure should investors have? "We suggest that 20 to 25 percent of equity investments be in foreign investments," says William Stone, the chief investment strategist at PNC Wealth Management.

When choosing which foreign equities to buy, Saut urges investors to "keep it simple." He suggests starting with a well-balanced mutual fund that provides exposure to a broad range of emerging markets, and perhaps adding an ETF that tracks the stock index of a higher-growth foreign market, like that of China or Brazil.

Observers expect the emerging market growth to benefit American-based companies as well—but some more than others. Large multinationals that do significant business overseas, such as Procter & Gamble, Honeywell, and Johnson & Johnson, are well positioned to succeed in the global economy of the next 25 years, Metz says. And on account of its expansive multinational operations, Saut is particularly bullish about General Electric's 25-year outlook. "If I had one stock to own—and only one stock—it would be GE," he says.

So while no one knows what the next 25 years may hold for the U.S. economy, broad exposure to foreign assets and American-based multinational stocks can help investors make the most of the coming market—no matter how bullish or bearish it turns out to be.