It Will Get Better, or It Will Get Worse
Many of you have heard market technicians on CNBC, Bloomberg, Fox Business, or CNN Money say things like, “We think XYZ stock is going higher- unless it doesn’t, in which case we think it will go lower.” While this type of “on the one hand, but on the other hand” forecast may appear ridiculously obvious, it does appear applicable in the current financial markets environment.
2022 was the seventh worst year since the inauguration of the S&P 500, ninety-five years ago in 1928. Deutsche Bank wrote that 2022 was the biggest down-market outlier in history, as it was the only calendar year that the total returns of both the stock market and bond market were worse than -10% going back to 1872 (1). So, we thought to take a closer look at what has happened after down years in the stock market(2).
It Will Get Better
70% of the time, down years are followed by a rebound year, and usually a strong one.
· Since WWII rebound years averaged 25%, and since 1928 rebound years averaged 28%.
· Only three times was the rebound year less than 15%
It Will Get Worse
30% of the time, down years are followed by another down year.
· The second down year was always worse than the first.
· And the second down year was followed by a still worse third down year around the Great Depression 1929-1932; WWII 1939-1941; Financial Bubbles Burst 2000-2002; but not Oil Embargo 1973-74.
In the chart below from the Macro Trends website, you can see that down years are usually followed by either nice pops or a triplet of increasingly negative years(3). Note that this chart excludes the impact of dividends.
S&P 500 Historical Annual Price Returns (3)
Source: https://www.macrotrends.net/2526/sp-500-historical-annual-returns as of 1/5/2023
Military conflicts are generally associated with rising stock markets (4), though there is often a decline as the military conflicts escalate. So, Russia’s invasion seems most likely to bring about a triplet of increasingly bad years if it escalates substantially or inspires aggressive actions in other parts of the world. Otherwise, a rebound year seems to be the most likely outcome in 2023, especially given that consumer confidence regarding the stock market was around 50-year lows in December of 2022, a good contra-indicator.
So where does that leave us? Odds are the stock markets will move strongly in one direction or the other, but they are unlikely to be flat with low volatility. We will continue playing the odds and positioning portfolios for an eventual rebound, noting that the leaders of the last bull market may not be the leaders of the next bull market. However, we are monitoring several situations closely and may change our minds and become more defensive if we believe that to be a better course of action.
Source: Guide to the Markets U.S. 1Q 2023. J.P. Morgan Asset Management, David Kelley et al.
Putting our financial planning hat on for a second, the current environment highlights how important it is for retired and nearly retired people to have a cash buffer, so that they do not have to dip into principal when investments have declined significantly. Our focus is on finding quality companies with an eye towards valuations that seem likely to allow for building wealth over the next 3-5 years. A cash buffer increases the ability to let the underlying investment theses in the stocks play out. Please let us know if you would like us to help build or revisit your current plan.
Redmond Asset Management, LLC January 2023
The opinions contained in the preceding commentary reflect those of Redmond Asset Management, LLC. The stated opinions are for general information only and are not meant to be predictions or an offer of individual or personalized investment advice. They also are not intended as an offer or solicitation with respect to the purchase or sale of any security. This information and these opinions are subject to change without notice. Any type of investing involves risk and there are no guarantees. Redmond Asset Management, LLC does not assume liability for any loss which may result from the reliance by any person upon any such information or opinions.
Redmond Asset Management, LLC (RAM) is an independent, SEC registered investment management firm located in Richmond, VA and is not affiliated with any parent organization. RAM was founded in 2005 and registered with the SEC on 22 Dec 2005. The company offers investment management services for equity, balanced and fixed income portfolios to corporate, institutional, and individual investors
(1) Allen and Reid (January 2023). 2022 Review: A year for the history books. Deutsche Bank Research