What Will the Stock Market do this Year?
At the beginning of each year, investors want to know what the stock market will do over the course of the next 12 months. Countless experts weigh in on the matter. However, as the table below demonstrates, there is little mystery regarding the new year’s expected market return.
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.
From the Behavioral Viewpoint
What is going on?
- We are easily Fooled by Randomness and have difficulty accepting the randomness of annual market performance. In response, we turn to predictions and are susceptible to what appears to be a plausible story presented by an expert.
- Using the trailing year’s return in coming up with the next year’s expected market return is an example of an Availability Bias, in which we make decisions based on the information that is currently available and easy to obtain. Given the randomness of returns year over year, we develop a false sense of certainty by relying on the prior year’s performance.
- Placing more emphasis on recent information while discounting older information is an example of Recency Bias. We are emotionally hardwired to consider what happened last year to be more relevant than what happened in years prior, even though research reveals that each yearly observation is equally important in estimating the average return.
- In trying to understand the world around us, personal experience trumps data and we are subject to Confirmation Bias, where we are more likely to believe things that support our already established point of view. We also make sense of things by means of stories rather than considering relevant information which drives our response to the return expectation stories that swirl around us this time of year.
What can we do?
- Design an investment portfolio with a well-planned strategic asset allocation based on long-term-goals and expected returns. Remember that equities are the highest performing asset class and historically delivered an average return of 10% with positive returns in 3 out of 4 years. Building wealth is a long-term endeavor that requires time and discipline.
- There is no magic to a portfolio assessment at every calendar year. Portfolio rebalancing should be implemented on a predetermined basis and when the strategic allocation is out of balance.
- Recognize that most predictions of market returns are speculative and relying on this type of information to reallocate portfolio assets can result in poor decisions.
Financial professionals can gain access to additional published behavioral investing resources by registering on our website:
IMPORTANT INFORMATION AND DISCLOSURES
The information provided here is for general informational purposes only and should not be considered an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. It should not be assumed that recommendations of AthenaInvest made herein or in the future will be profitable or will equal the past performance records of any AthenaInvest investment strategy or product. There can be no assurance that future recommendations will achieve comparable results. The author’s opinions may change, without notice, in reaction to shifting economic, market, business, and other conditions. AthenaInvest disclaims any responsibility to update such views. These views may not be relied upon as investment advice or as an indication of trading intent on behalf of AthenaInvest.
You are solely responsible for determining whether any investment, investment strategy, security or related transaction is appropriate for you based on your personal investment objectives financial circumstances. You should consult with a qualified financial adviser, legal or tax professional regarding your specific situation. Investments involve risk and unless otherwise stated, are not guaranteed. Past Performance is no guarantee of future results.