Except, that’s not exactly how it goes with markets. Sure, they do go up and down, but the long-term trend is up. Even when you consider the impact of inflation on stocks, there’s at least some upward trajectory over time. When you add in the reality that compounding can be a great benefit, that higher rate of return with stocks is understandably a place that’s appealing to many with long-term time horizons.
So stocks tend to go up over the long-term, and offer rates of return that are pretty good compared to lower risk vehicles. We know that. But what about when stocks have been going up for a while? In other words, do stocks get a lot more risky in a bull market?
I thought of this because as of this writing, stocks have reached historical highs here in the U.S. Naturally, there tend to be a fair number of people who start to get squeamish during protracted bull markets. In other words, they wonder when the floor will drop from underneath them prices will tumble.
There’s that saying that we should be fearful when others are greedy, and be greedy when others are fearful. I’m no Oracle from Omaha (far from it!), but maybe we should be careful to avoid being too fearful in bull markets. Perhaps we can hold onto that greed a little bit.
As I do on occasion here, I pulled and analyzed some historical stock data to figure this out. In this case, I took historical S&P 500 data for just over 63 years – from January 1950 to November 2013. Based on this available data, I analyzed the annual yearly change in the market price in the context of bull markets. Here is what I found:
Finding #1: Stocks tend to follow a strong year with another solid year
How do you define “strong year?” In this case, I defined it as a year with returns of 20% or more. Since 1950, there have been 17 such full years. In the year following a strong bull market year, stocks average a nearly 11% rate of return!
So, if you’re in a year that happens to be very good – where there is a bull market – the following year tends to have strong performance too. Now, these are averages of course, and there were some subsequent years that were awful. No streak continues forever! But some were good, and clearly the average of nearly 11% is very solid
Finding #2: Stocks still don’t automatically fall after a strong 2-year period
So, we talked about one year in the previous finding. What if we expanded it to 2 strong years? In this case, we’ll define a strong 2-year period as one with a total increase of 35% over that time frame. There were 13 such 2-year time periods since 1950.
In the year following 2 years of bull-market performance, stocks average a return of just over 4%. So, after 2 years of well-above average returns, things tend to come back down to earth. However, it’s not like a return of around 4% is a total disaster. There are far worse “safe” alternatives, though it should be pointed out that with stocks there is a range of good and bad years in there.
What are the implications of these 2 findings? I see this as a lesson to be learned, that just because stocks have gone up quite a bit during the course of 1 or 2 years, it doesn’t mean that they’re ready to start crashing. Of course, going from 1 strong year to 2 strong years collectively can decrease the odds of subsequent strong returns. However, clearly there is often longer life to bull markets than might occur to the more risk-averse investor.
As I write this, we are in the midst of a situation that basically fits both of these scenarios above: 1) Annual returns > 20% (YTD through mid-November), and 2) a nearly 2-year return > 35%.
Food for thought, as you consider what type of scenarios might happen next.
My Questions for You
Do you get worried that stocks will fall, after a prolonged bull market?
Do you agree that bull markets have a longer life than one might realize?
What are your current thoughts – positive or worried – about the markets might be headed?