Regardless of whether the previous year return was awful, wonderful or simply run-of-the-mill, the average return for the subsequent year is right around the 90-year average of 12%. Compounding the annual returns over this timeframe results in the familiar 10% figure, which is our best estimate of how the market will do this year.
LAST YEAR’S RETURN IS NOT PREDICTIVE OF THIS YEAR’S RETURN (S&P 500 Annual Returns 1926 – 2016)
Source: S&P Dow Jones Indices LLC
This 90-year period encompasses a wide range of economic conditions, from a deep depression to roaring expansions. Robert Schiller, a 2013 Nobel Prize Laureate, shows convincingly that market volatility, as measured by standard deviation, has little to do with changing economic fundamentals. Calendar year stock market returns often differ from the long-term average, sometimes by a large degree. The differences are the result of unpredictable and unforeseeable events and the subsequent short-term investor reaction.
Over the long-term, research reveals the market to be a no-memory process, pumping out returns year after year with the same average regardless of what has happened recently. So, estimating the expected return for the market should not be based on what happened in the previous year.
A popular activity among investment professionals and the media is to predict stock returns for the upcoming year. Last year’s results, current conditions and speculation about anticipated events are woven into a story that makes their claims seem plausible. Investors seeking to reduce uncertainty and the associated anxiety are attracted to such prognostications, but as 2016 reminded us, even experts can’t predict the future.
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