Bear markets sometimes creep up on us, without creating widespread awareness. Last year may have been one of those years. The performance of U.S. stocks in 2007 resembled, to a surprising degree, the performance of stocks in 2000—a year widely perceived as a bear market.

In 2000, the average domestic stock lost 5.1%, while in 2007 the average stock lost 3.2%. Median returns were nearly identical in both years (-13.8% vs. -13.3%), as were share-weighted returns (-1.5% vs. -1.6%). In both years, about 60% of all stocks had a negative return. So what was the difference between 2000 and 2007? Mega-cap stocks did badly in 2000 (i.e., the S&P 100 lost 12.6%), whereas in 2007, mega-cap stocks were up (the DJIA gained 8.9%, the S&P 100 6.1%).

To understand how the performance of mega-stocks hid the bear market in 2007, let's dig a little deeper into the performance of the U.S. equity market by looking at prominent capitalization-weighted equity indexes. Market capitalization is the product of the number of outstanding shares and price per share.

A Mixed Year for Equities

As you look at the returns of prominent U.S. equity indexes in 2007 (see "Hiding a Bear Market"), they generally present a picture of modest performance. Lurking under the aggregate indexes, however, is a different reality, as shown by the return of the Dow Jones Wilshire 5000 Equal Weighted Index (-6.7%).

Digging deeper, we discover that the mean equal-weighted, one-year return for all 6,342 stocks in the Morningstar database during 2007 was -3.2%, while the median return was -13.3%. A median return below the mean return reveals broad weakness that is often hidden by tip-of-the-iceberg cap-weighted indexes.

In fact, nearly 64% of all 6,342 individual securities in the Morningstar database had a negative return in 2007 (see "Performance Picture"). The mean equal-weighted return for the 4,053 stocks with a negative return was -36.8%, while the median negative return was -31.1%.

But the glass is not entirely half-empty. There were 2,289 individual stocks that had a positive return in 2007. The average return of stocks with a positive return was 56.3%, and the median return of stocks with a positive return was 26.7%. These results represent the returns of all 2,289 stocks being equally weighted. But because nearly all prominent equity indexes are capitalization weighted, I share-weighted the returns of all 6,342 stocks to create a performance figure analogous to market-cap weighting. The share-weighted return of all U.S. stocks in 2007 was -1.6%. By comparison, in 2006 the share-weighted return of all stocks was 18.5%. That the share-weighted return (-1.6%) was higher than the equal-weighted mean return (-3.2%) suggests that larger stocks (as measured by outstanding shares) tended to perform better than small stocks in 2007.

In fact, the share-weighted return for U.S. stocks in 2007 (-1.6%) was basically the same as in 2000 (-1.5%). Interestingly, several other equity performance measures in 2007 (mean return, median return, percentage of stocks with negative return) were also similar to the same measures in 2000. And yet, based on the performance of prominent indexes, 2000 and 2007 don't look similar at all, except for the equal-weighted DJ Wilshire 5000.

U.S. Equity Mutual Funds

Now let's look at U.S. equity mutual funds (see "Performance Picture"). There were 2,691 funds that survived the entire year of 2007. Only those domestic equity funds with at least 12 months of performance as of Dec. 31, 2007, were included in this analysis. Furthermore, funds with more than 15% of their portfolios in cash, bonds or non-U.S. stock were left out. Redundant share classes were also omitted. These filters allow for a more sensible comparison with the performance results of individual equities.

The mean equal-weighted one-year return of equity funds in 2007 was 5.4%, while the median return was 5.2%. The asset-weighted one-year return (a figure I calculate by weighting each fund's one-year return by its percentage of the total fund assets of all 2,691 funds) was 6.3%. As with stocks, this suggests that larger funds (i.e., funds with more assets) performed slightly better than funds with small asset bases—or, that by year-end, the better-performing funds had attracted proportionally more assets. The former is probably more likely.

There were 720 funds—nearly 27% of the group—that had a negative one-year return in 2007. The average negative return of those funds was -7.1%, while the average return of the 1,971 funds with a positive return was 10%. The best-performing domestic fund in 2007 gained 55.2% (Fidelity Select Energy), while its worst-performing cousin lost 58% (iShares Dow Jones US Home).

Stock vs. Funds

Now let's compare the performance of stocks and mutual funds over longer time frames. As shown in "Survivors' Tales" (see above), 55% of all the stocks that survived the three-year period ending Dec. 31, 2007, had a negative three-year annualized return. By comparison, less than 2% of all mutual funds that survived the full three-year period had a negative return. The average three-year equal-weighted return of all stocks was -5.2%, compared with 8.5% for all U.S. equity mutual funds (also an equal-weighted figure).