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By: Tim Bennett
31.01.2020
31.01.2020
A quick glance at history reveals the folly of trying to predict this year’s stock market performance by looking at last year, as Tim explains.
Background
Will gravity take over?
There are certain rules of nature that also apply to the stock market. One is gravity and the idea that what goes up will eventually come down. The other, similar, concept is mean reversion and the idea that everything reverts towards its long-term average, whether you are talking about the length of snakes or stock market cycles. The challenge, however, is predicting either the timing or extent of any correcting move when it comes to share prices. This is true in both directions.
A snapshot
A quick look at some historic data makes this point forcefully. Ben Carlsson at awealthofcommonsense.com has looked back at S&P 500 average annual returns since 1926. Specifically, he has looked at what happens immediately after an up or down year of varying magnitudes.
What the data shows is that the American stock market has tended to make decent positive returns on average but predicting what will happen year to year is very hard within that trend.
Some key facts
This data set allows him to draw some interesting conclusions about very strong bull years of the type we saw in 2019.
In short, it is unwise to take a firm view about the year that follows either a strong rise in the market, or the opposite because the data makes it clear that this sort of forecasting is fraught with risk. Although many people are paid to try nonetheless, their chances of being right are small.
Conclusions
All an investor can do is position themselves to take advantage of some of the trends we can observe from the stock market over long time horizons.
Takeaways
The data analysed by Carlsson suggests that time in the market is always a better approach than trying to time the market – whilst some people will get their short-term calls right, most investors won’t and run the risk of damaging their long-term returns in the process. The data also makes the case for not getting bogged down in short-term “noise” and opinion about the market, especially if it might lead you to react.
To find out more
Feel free to email me [email protected] or contact an Adviser.
