The list itself seems to run contrary to Morningstar’s own institutional thinking. The firm has always been focused on the long haul, with virtually every analyst I have ever talked to far more concerned with what a fund will do over the next five years than the next 12 months.

From the start, the editors of the newsletter have hedged their bets a bit, suggesting the selections were for the next year “and beyond.” This year, Karen Anderson, taking her first shot at the list as editor of Morningstar Mutual Funds, makes no bones about the idea that “whether you’re constructing your portfolio for the first time or looking to make some upgrades, I’ve compiled a list of offerings that investors should consider for the long haul.”

But when you say you are producing a list of “the best funds” for the coming year, you create an expectation that the issues you pick will actually be good performers in the year ahead. There, Morningstar hasn’t done so well.

Over the first five years of this endeavor, 71 funds were named to the list (in about one-seventh of those picks, a fund actually made the list for a second or third year). Using year-to-date data for 2009, nearly two-thirds of the funds picked landed in the top half of their peer group during the year for which they were expected to be “best.”
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“Morningstar has a lot of smart people who are trying their best, and who are smart statisticians,” said Mark Hulbert of the Hulbert Financial Digest, which ranks the performance of investment newsletters and is a service of MarketWatch, the publisher of this report.

“What they are revealing with these lists,” he added, “is just how difficult it is for any of us to identify top performers, to say ‘This is what’s going to be the next great investment.’ Even among funds with absolutely fabulous track records, picking next year’s winners is tough.”
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If you consider that every Morningstar editor creating this annual list has suggested that the funds they picked would be good long-term performers, then the one calendar year that now has a five-year history — the picks for 2005 — should have all been long-term winners. That didn’t happen. While 20% of the picks from that year rank in the top 10% of their peer group, roughly half of the “best funds for 2005” fall below their category average over the last half decade.

It’s not just the performance that is the problem with this list. If you tried to use it to build a portfolio, there would be significant overlap. Each year’s list is published without reflection on the previous year, or any mention of what someone might do if they bought those other funds. Moving from one annual list to the next would generate tremendous turnover.
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Instead, the “best funds for 2010” is more like a gimmick — fun to read and to chat about, but not in keeping with the long-term thinking that investors (and Morningstar analysts) typically use.

Undeniably, stocks are still “cheap” compared to the record overvaluations of 2000 and 2007. In order buy stocks on that basis, investors must accept the prospect of unsatisfactory long-term returns in any event, but they are free to speculate as long as they are willing to treat 2000 and 2007 as normal, and to rely on the market pressing to even greater overvaluation in order to achieve satisfactory near-term returns.

It is also true, however, that market valuations since 1995 have been distinct outliers from a historical perspective (as are the disappointing overall returns). That does not imply that near-term returns must be negative. While we continue to observe weak sponsorship from a volume perspective, flattening momentum, increasing non-confirmations, and some early pressures in yields and credit spreads, we have not observed sharp internal deteriorations at this point. As a result, it is unclear whether or not investors will continue to speculate for a while. Even so, it is already evident that the longer-term outcome of risk-taking here will almost undoubtedly be unrewarding.

In short, any virtue of stocks here is decidedly speculative. Stocks are overvalued to a level from which uninspiring returns have always followed. That fact is true regardless of whether or not the economy is in a sustainable recovery.
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As part of our ongoing attention to what I’ve called “second wave” credit risks, we’re just beginning to hear concerns about fresh credit problems, foreclosures and loan losses from other corners. A few of these concerns are from particularly credible voices, which makes us feel, well, slightly less alone in our analysis.
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“I think that first quarter of next year we’ll see a new wave of foreclosure activity. Delinquencies have been going up – we have five and a half million homeowners who are late on their mortgage payments right now, and many of those, under normal circumstances, would have already been in foreclosure. But the Treasury is asking lenders to make doubly sure that anybody who qualifies for the HAMP program or other modification program gets in those programs. We think we’ll probably hit the historic peak next year, in 2010, as a lot of the Option-ARM loans reset, as unemployment related foreclosures peak, before numbers finally start to settle down a little bit in 2011. We’re expecting the first quarter to be pretty ugly.”

Striking a similar chord, on Tuesday, Meredith Whitney appeared as the guest host on CNBC’s Squawk Box. Whitney was one of the few Wall Street analysts who foresaw the recent credit crisis, and also anticipated what I’ve called the “March-November 2009 lull” in credit difficulties. Having been generally positive on the financials since the first quarter, she recently became quite negative. At the end of the broadcast, when asked to end on just one short, positive note, she replied, “The Blind Side was an amazing movie.”

Whitney noted, “In the second quarter, you had banks recapitalizing themselves with huge equity volumes, you had a lot of write-ups throughout the year, but the core loan books have been declining dramatically, so what’s left? The toxic assets have all been written up. There’s a very limited cash market for them. You would never know about the degradation in asset quality (of loans backed by Fannie Mae) because the government has been buying the paper. The paper has never traded higher. There’s still time (for toxic assets to become a major problem again). They have to because there are not cash flows to support the payments on those bonds, and the bonds will break covenants. What’s happening is that the banks are going to have to start selling stuff, and so you’ll start seeing a yard sale to raise capital.”

One of the main concerns Whitney expressed was the collapse in credit availability. “In the last cycle in the early 1990’s, the economy slowed and banks stopped lending but the securitization market was really getting started, so consumers actually had more liquidity. Now, consumers and businesses are being stuck by – banks aren’t lending and there’s no securitization. So you haven’t had this amount of credit contraction. There has been a trillion and a half of credit taken away from credit card lines, and that is accelerating with all the regulatory changes. So the numbers just aren’t big enough from a government standpoint to mitigate the decline in credit, which is ultimately going to influence behavior. The component parts do not add up. You cannot get to a robust economic recovery with so many states under duress.”

So long, 2000s. And no need to pass the tissues. We won’t get too weepy about this goodbye.

The past 10 years have been the worst decade ever for stocks, reports The Wall Street Journal. We suffered through two bear markets, and stocks on the New York Stock Exchange lost 0.5% a year, on average, since the end of 1999.

And if that doesn’t hurt enough, try rubbing some inflation on that wound. If you adjust for inflation, the S&P; 500 index has lost 3.3% a year since the 1999, the Journal reports.

No other decade has been this bad. Not the 1970s with its runaway inflation and bear market. Not the 1930s with its Depression years.

How could this happen? The 1990s pushed stock prices too high, and they came into the decade ridiculously overvalued, experts tell the Journal. Stocks in the S&P; 500 started off this decade at about 44 times earnings — and there’s nowhere to go but down in that scenario.

Even now, those stocks are at about 20 times earnings, which is higher than the historical average of 16.

So did anyone come out from this decade a winner? Gold owners, who saw the price of the previous metal spike an average of 15% a year. And bond owners, who earned returns in the 5% to 8% range.

And if this was the worst decade ever for stocks, you can bet that the economy was similarly miserable.
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So what can we blame for the horrific numbers? Even the Journal (gasp!) suggests that we can point a finger at American capitalism.