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A Stock Market History Lesson

 

Memories of the great Olympic moments we experienced this summer have faded and been replaced by the image of a bad call on Monday Night Football. Thankfully the regular NFL referees have come back on the field to rescue the season. Week 4 of the season marked their return. It also marked the end of third quarter of 2012 and while we wait for next week’s football games, we have a moment to reflect on what transpired over the course of the first nine months of the year in the stock market.

 

It is exceedingly clear that the feeling of uncertainty that crept back into familiarity in 2011 remains with us. These doubts didn’t impact just average investors (who struggled in 2011); hedge funds also experienced one of their worst years on record. So far, 2012 is not shaping up to be much better. Despite the strong gains that the market has produced this year, many investors refuse to believe that demand is in control and that US stocks remain the strongest of the 6 major asset classes (domestic stocks, bonds, foreign currencies, commodities, international stocks and cash). 

 

Recently The American Association of Individual Investors (AAII) released their weekly sentiment report, showing that bullish sentiment among investors had climbed (with the market reaching new 52-week highs) to 36.46%. Interestingly, this reading is still below the long-term average bullish sentiment reading (since 1987) of 39. The current reading is also beneath the data points from October 2008, arguably the worst month the stock market has ever experienced (Source: AAII). 

 

Through 9/30/2012, the S&P 500 [SPX] is up almost 15%.The SPX gained approximately 6% in the  3rdquarter alone. Two sectors (Healthcare and Telecom) were up more than 10% for the quarter. Many Investors have missed these gains because they have a hard time staying invested when it "feels" like the wrong thing to do. They think about "what ought to be" not "what is". The central truth for the stock market in 2012 is that price action has favored an offensive posture. What is, "is"! 

 

If you check the yearly returns for the SPX going back to 1928 (as the authors of Dorsey Wright & Associates’ Daily Equity Report for September 27, 2012 did), the market has produced a positive yearly return nearly two-thirds of the time (55 out of the 84 years or 65% of the time). Here are several other historical observations about the market (as measured by the SPX) taken from Dorsey Wright & Associates’ work to consider: 

  • In 42 out of the past 84 years, or 50% of the time, the SPX has gained 10% or more, and in nine of those years the SPX was up 30% or more.

  • In 19 out of the 84 years, or 23% of the time, the SPX closed the year down 10% or more, and in three of those years the SPX was down more than 30%. 

  • 2008 stands out like a sore thumb as this is one of the three declines in the SPX of 30% or more; the other two came in 1931 and 1937 (1974 was close with a return of -29.72%). 

  • From 1978 through1999 there were no yearly declines of 10% or more, which came on the heels of a 20 year stretch from 1957 to 1977 where the SPX experienced seven 10% or more yearly declines. 

 

Of course, there is no telling what the future holds, so there is no sense it trying to predict it. There may come a time when we run into another market like 2008 where the SPX drops more than 30%; however, this is an occurrence that has accounted for just 3.5% of the years in the 84-year history of the SPX. It's all well and good to prepare for the 3.5% of the time, but what about the other 96.5%? 

 

Back to football for a second. According to a recent "Sports on Earth" article, 93% of the plays run during the 2011 NFL season were run out of "traditional" offensive formations (i.e. 1 RB, 3WR, 1TE, etc.). Only 7% of the plays run were "gimmick" or "trick" plays like fake punts, fake field goals, wildcat, etc. Knowing this as a coach, do you spend an entire season's worth of training on practicing how to defend against a fake punt or fake field goal? Not likely. Defending against these play calls is something you will have in your playbook and will have practiced during the season, so you can be ready if the time and circumstances warrant it. Otherwise, training will likely focus on sharpening the skills that will be used in the other 93% of the plays run. 

 

This same story can be applied to the market. You should have a plan should the worst occur (another 2008, for example). However, If history is any guide, 96.5% of the time the SPX will produce an outcome that does not resemble 2008 (i.e. a 30% or more decline) and 65% of the time the market will actually finish the year on a positive note. So the majority of your efforts should be spent sharpening your skills and honing your craft to take advantage of the opportunities the market presents. Most investors have missed the opportunities this year, let alone the last four years because they have been preparing for and worried about the 3.5%. 

IMPORTANT DISCLOSURE

 

Nathaniel Prentice is an Investment Advisor Representative at Altium Wealth Management LLC. Altium Wealth Management is a registered investment advisor with the U.S. Securities and Exchange Commission. Information is provided for educational purposes only and should not be considered investment, financial planning or tax advice. Please contact an Altium financial advisor or any tax or financial advisor for advice on your specific situation.

 

All data is provided by Thomas Reuters. Accuracy of the data is not guaranteed.

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