Friday, February 14, 2020

What to Expect After a Year of 20% Returns?

Pathways Advisory Group, Inc.
Jeff Karst, CFP®

Last year was a phenomenal year for stocks.  The S&P 500 Index (a measure of large US stocks) had a positive return over 30% and the MSCI EAFE (a measure of large foreign stocks) was up over 20%.
With a stellar year like this, what can we expect for 2020?  

Since last year was up so high, should we expect stocks to fall this year?  Is there any truth to the claim “what goes up must come down”?  Or will stocks continue on their upward trajectory?  We looked back historically to determine if there is some consistency in how the S&P 500 behaves following such a great year.

Since 1926, the S&P 500 has had 34 calendar years (excluding 2019) with a return in excess of 20%.  We then looked at the annual return of the following year for each of those 34 calendar years.

After those great years, the S&P 500 had a positive return 23 times (roughly two-thirds of the time).
Of those 23 years with a positive return, 20 of them had a return over 10% for the year.  And about half of those 20 saw a return in excess of 20%.

Does this mean that I’m predicting a positive year for stocks?  Of course not. However, we can say that one year of great performance doesn’t automatically tell us to expect poor performance the next.

Look at the following two charts that show the frequency of returns for all years, versus the frequency of returns for years following one with greater than 20% return.  The only conclusion to make is that a year following a great year will probably look like any other year.  In other words, think of any given year as being independent of the year that preceded it.

Note: These graphs only describe past performance and shouldn’t be used to make investment decisions.

It’s always tempting to try to time markets based what’s happened recently. There’s also the thought that there’s “gravity” in stock markets – that things have to come down in value simply because they’ve gone up. But historical data shows that this hasn’t been the case and can’t reliably be used to make good investment decisions. 

We prefer to keep a long-term investment approach. Be broadly diversified, control costs and taxes, and keep the focus on the long-term goals your investments are meant to serve. 

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