The Independent Market Observer

What Will the Market Return This Year?

Posted by Peter Essele, CFA®, CAIA, CFP®

This entry was posted on Feb 13, 2015 12:49:00 PM

and tagged Investing

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what will the market return this yearI hope you enjoy today’s insightful post from my colleague Peter Essele. See you next week! — Brad

“What will the market return this year?” As a portfolio manager, I hear some variation of this question at the beginning of each and every calendar year. Following the requisite exchange of pleasantries, it inevitably comes up at cocktail parties, birthday get-togethers, client meetings, and even the après-ski scene.

The truth is, nobody really knows

Many people like to throw out a number, and the phrase we often hear is “high single digits,” which equates to something between 7 percent and 9 percent. It’s not a bad guess, in fact, because the S&P 500 has returned roughly 7 percent, on average, since its inception.     

These estimates are generally an extrapolation of the market’s most recent returns. In years following strong markets, the forecasts tend to be higher, and they’re often lower after years with meager returns, like 2008 and 2011. Our behavioral biases suggest that recent trends should continue, so the natural result is a forecast based on recent history.

As mentioned, the average return of the S&P 500 since 1928 has been around 7 percent, with a standard deviation of 19. Therefore, based on a normal distribution, the index has achieved a return profile of 7 +/− 19 percent, roughly 68 percent of the time. Simply stated, you could reasonably expect a return between −12 percent and 26 percent in two out of every three years if the market exhibits similar characteristics to what we’ve seen in the past.

Of course, commentators can’t use this type of estimate because it’s not easily consumed, and the range is far too wide to impress anyone. Instead, what you’ll often hear is a punt, such as "the high single digits," especially after a period of strong market performance.

So, what about this year?

Once again, the prevailing forecast is an equity market return in the high single digits. But how often has the S&P 500 provided this type of return to investors?

Let’s look back at history. The chart below shows the range of S&P 500 calendar returns since 1928, with the lowest return coming in at −47.07 percent and the highest at 46.6 percent. The red square represents calendar-year returns of between 6 percent and 10 percent.

what_will_the_market_return_this_year

Source: FactSet/Commonwealth Financial Network

Since 1928, the price return of the S&P 500 has come in at high single digits in only five calendar years, or roughly 6 percent of the time. In addition, a 7- to 8-percent rate of return has only occurred twice over this period, or less than 3 percent of the time. Considering an average return of 7 percent, standard deviation of 19, and very few occurrences in the aforementioned range, it’s likely that the S&P 500 won’t achieve a high-single-digit return in 2015, as many have predicted.

Here’s a more reasonable estimate: an average return of 7 percent over the next decade.

The next time a cocktail-party conversation turns to predicting the market's performance, try responding with “7 percent over the next decade, on average." After all, you’ll have a two-thirds chance of getting it right.

                                     

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The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

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