A reader asks:
Of course, it’s great that the S&P 500 is up 20% this year, but aren’t we just pricing in the Fed’s inevitable rate cuts in 2024? Should we really expect the market to rise again next year after surprisingly positive this year? Make me skeptical. Full disclosure: I am pessimistic by nature and take a bit of an anti-Ben stance on the markets.
See, that’s what makes a market!
Anti-Ben is justified in asking whether the current upswing in the stock market is pricing in interest rate cuts for next year. After all, the stock market is future-oriented.
I love studying historical market returns. Looking at market history will never help you predict the future, but it can help you better understand how the stock market works in general.
For example, looking at annual returns in the stock market won’t tell you what will happen next year, but it can help you prepare for a range of outcomes to establish something of a baseline.
One of my favorite market statistics of all time is the fact that the US stock market has had more 20% rising years than negative years since the 1920s. This is true.
Since 1928 there have been 34 calendar years1 where the S&P 500 is up 20% or more compared to a total of 26 years of losses.2
This means that the stock market rose 20% or more in 36% of all years and fell in 27% of all years. That’s a pretty good trade-off, especially considering that the average down year represents a loss of about 13%.
The question Anti-Ben seems to be asking here is: What’s happening? after a 20% profit?
Here are all 20% plus years along with the following year’s returns:
Not that bad. Definitely more green than red. Here are the summary stats:
- The stock market has seen an increase in 22 of the 34 years, having recorded a gain of 20% (65% of the time).
- The stock market fell in 12 of the 34 years after rising 20% (35% of the time).
- The average return after a year of gains of 20% was 8.9%.
- The average increase was +18.8% in the up years.
- The average loss in the default years was -9.1%.
- There were 19 years of double-digit increases.
- There have only been two years with double-digit declines (1936 and 2022).
This year is on the verge of another 20% increase. We’ll see if Santa is there for us by the end of the year or not, but so far everything is good.
It is also important to ask how much one year’s return actually affects the following year’s return. Here’s a look at the average returns after a strong upturn year, an upturn year, a downturn year, and a strong downturn year:
So perhaps the starting point of 20% is less important than one would think.
I’m sure the data could be broken down to provide more signals, but there doesn’t seem to be much correlation from one year to the next.
Most of the time stocks go up, but sometimes they also fall.
It’s entirely possible that the stock market has priced in Fed rate cuts early next year. The S&P 500 won’t wait for Jerome Powell to clarify. Inflation is falling, interest rates are falling, and wage growth is falling, so it makes sense for the Fed to start cutting rates sometime in the first half of 2024.
But I can’t claim to be smart enough to know how much of it is priced into the stock market or what’s coming next.
Historical return numbers can help set expectations, but it’s also true that things happen in markets all the time that have never happened before.
I don’t know if we are setting up for a new bull market, a flat market or a new bear market.
Successful investors know that it is impossible to predict the coming market environment. The best thing you can do is prepare for a variety of outcomes to avoid letting short-term market movements influence your behavior.
We explored this question in the latest Ask the Compound:
Tax expert Bill Sweet joined me again to answer questions about bond fund returns, selling large individual stock positions, direct indexing and when to pay off your mortgage early.
What returns can you expect on the stock market?
1Without 2023… not yet.
2There were only six bad years with losses of 20% or more.