Chances are good that the stock market will be higher 12 months from now.
The odds are actually two out of three.
These odds are not based on any privileged view of whether the economy will experience a soft decline, the future direction of Federal Reserve interest rate policy, or anything else. Instead, they are based on the stock market’s historical tendency to rise in two out of three 12-month periods—whether those periods come after a roaring bull market or a punishing bear market.
To calculate these coefficients, I focused on the inflation-adjusted total return of the stock market since 1871, based on data collected by Robert Shiller of Yale University. Averaged over all 12-month periods over the past 150+ years, the market rose 69.2% of the time – very close to two out of three. That’s the starting point.
Next, I compared this baseline to the percentage of positive one-year returns that followed months in which the stock market had declined over the past year. The percentage of this subset was essentially the same at 70.4%.
What this means: The probability that the market will rise over the next 12 months is no different just because the market today has fallen over the past year. (The underlying assumption behind this argument, like all others in this column, is that the future is like the past. If that assumption is false, all bets are off anyway.)
This conclusion may seem too good to be true. To confirm this conclusion, I next focused on all months since 1871 when the market was down. every 1, 3, 6 and 12 month periods. In the year following these miserable months, the stock market rose an average of 65.4% of the time. The difference between this percentage and my baseline is not statistically significant.
While you might be surprised by such results, you shouldn’t be. It is exactly what is expected of an efficient market: it rises or falls at any time to a level that leaves it with roughly the same probability. For example, if the odds that the market will rise over the next year fell significantly below two out of three, the stock market would fall today to reflect the lowered odds – rather than wait. It would stop the decline when the odds have risen to roughly equal the historical baseline.
While two out of three odds are nothing fancy, these are roughly the odds that the US stock market has set for over a century. We should not expect these ratios to change significantly from year to year. And that’s exactly what I found.
A good analogy is flipping a coin: The probability of tossing a head is the same regardless of whether you have previously rolled five heads in a row or five tails in a row. To think otherwise is to be guilty of the so-called “player fallacy”.
This is not to say that the stock market and coin tossing are equivalent. But it is the case that playing the stock market in the short term is basically gambling.
This is why our moods are such an unreliable investment guide. Our view on the market’s 12-month outlook should be the same today as it was a year ago, although the S&P 500 SPX,
in October 2021 had a dividend-adjusted gain of 36.1 percent trailing 12 months — as opposed to a current loss of 15.0 percent.
So cheer up!
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings are tracked by investment newsletters that pay a flat fee to review. He can be reached at [email protected].
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