Content provided by Scott Kubie, CLS Chief Strategist
Predicting the stock market’s return is hard. I don’t remember a lot of people predicting an up 30 percent for the market last year. In fact, during this time of the year, the only thing more certain than people rapidly breaking New Year’s resolutions is stock market strategists predicting the market will rise between 5 and 15 percent in the coming year. Since 2000, the average estimate by strategists for calendar year total return is 10.7 percent. Only four times (2000, ’01, ’03, and ’05) has the average been outside the 5 percent to 15 percent range.
These predictions feed into an underlying human bias for bell curves. We like items with a high probability of results around the average, with some hope that things can go extremely well and some risk they can go poorly. The problem is that stock market returns provide the exact opposite experience.
The chart below, from Northern Trust, shows the S&P 500’s historical return distribution from 1925 to 2012. As expected, the market is about as likely to deliver a negative return as a strongly positive one. Negative returns are just 2% more likely than returns 25% or greater. What is unexpected is these two probabilities account for 54% of the years!
This is type of distribution isn’t a fun one to face. One of the axioms I remember from science is, “nature abhors a vacuum.” Investors seem to as well. Excesses aren’t worked off slowly; they are worked off quickly and often overshoot.
So in the spirit of the season, I suggest the following resolutions regarding prognosticating annual stock market returns:
- Attach probabilities to various outcomes – CLS’s are available for advisors to download and share with clients at https://apps.advisorlynx.com/secure/shared/images/CLSProd/EditorContent/staticLinks/clientPieces/Other/StockMarketOutlook.pdf
- Predict that the market won’t go up about 10 percent – it’s provocative and you are very likely to be right
- Copy Nobel Prize winner Robert Shiller and predict longer horizons – the bell curve starts forming as you stretch out the horizon
- Talk about the NFL playoffs – by the time the Super Bowl is over people won’t ask
If all else fails and you have to guess a number, go high or low.