Chances are good that the stock market will be higher in 12 months.
The odds are two out of three, actually.
These probabilities are not based on any favored idea of whether the economy will experience a soft landing, the future course of Federal Reserve interest rate policy, or anything else for that matter. Rather, they are based on the stock market’s historical tendency to rise in two out of three 12-month periods, whether those periods come in the wake of a roaring bull market or a punishing bear market.
To calculate these odds, I focused on the inflation-adjusted total return of the stock market since 1871, using data compiled by Robert Shiller of Yale University. Averaged over all 12-month periods over the past 150+ years, the market has risen 69.2% of the time, or very nearly two out of three. This is the baseline.
I then compared this baseline to the percentage of positive one-year returns after months in which the stock market had fallen in the previous year. For this subset, the percentage was essentially the same at 70.4%.
What it means: The odds of the market going up over the next 12 months are no different just because the current market has gone down over the past year. (The assumption underlying this statement, like all the others in this column, is that the future will be like the past. If this assumption is false, then all bets are off anyway.)
This conclusion may seem too good to be true. So, to stack the game against confirming this conclusion, I then focused on every month since 1871 in which the market was down each periods of 1, 3, 6 and 12 months. On average, in the year since those dismal months, the stock market has risen 65.4% of the time. The difference between this percentage and my baseline is not statistically significant.
Market efficiency
Although you may be surprised by such results, you shouldn’t be. This is exactly what is expected of an efficient market: it will rise or fall at any time to any level that gives it roughly the same probability of rising. For example, if the odds of the market rising over the next year fell significantly below two in three, then the stock market would fall today to reflect those reduced odds, rather than waiting. It would stop falling when the odds had risen to be more or less equal to the historical baseline.
While there’s nothing set in stone about the two-out-of-three odds in particular, those are pretty much the odds the US stock market has been setting for over a century. We should not expect these probabilities to change significantly from year to year. And that’s exactly what I found.
A good analogy is flipping a coin: the odds of flipping heads are the same whether you’ve already flipped five heads in a row or five tails in a row. To think otherwise is to be guilty of the so-called “gamer fallacy”.
This does not mean that the stock market and coin flip are equivalent. But it is true that playing the stock market in the short term is basically playing.
This is why our moods are not a reliable guide to investing. Our attitude towards the 12-month market outlook should be the same today as it was a year ago, even though the S&P 500 SPX,
in October 2021 was sitting on a dividend-adjusted 12-month gain of 36.1%, compared to a loss of 15.0% currently.
So rejoice!
Mark Hulbert is a regular MarketWatch contributor. His Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be contacted at [email protected].
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