Where is the market headed next?

The S&P 500 index reached its peak in January 2022 and then proceeded to fall through most of the remaining year. By June 2022, it had dropped 20% below its peak and thus officially entered a bear market. From there it went on to further decline, eventually reaching a bottom in October at nearly 25% off its peak. Peak to trough drawdown stretched out over ten months.

Since that October low, the market has been recovering in fits and starts. Today, about eleven months into this gradual recovery, the S&P 500 is still 7% below its January 2022 high. From its October trough, it has since gained about 25%.

So where is the market headed next? Would it complete a full recovery by the end of this year? Or fall off its current highs? The future is largely unknowable so we cannot say for sure what might happen next. On the other hand, we could still gain some insights from looking into the historical data.

Three years ago, I compiled some market data for each calendar year with rolling 1-year, 5- and 10-year periods. I calculated the probability of any one-year negative S&P 500 return to be about 27%. So today we can argue that the possibility of S&P 500 decline over the next 12-month period is roughly one-in-four. But I don’t invest in stocks for one-year returns. If I extend my time horizon to the next five-years, the possibility of negative return in the next five years drops down to just one-in-ten, or 10% of the time. See the numbers in this post: The odds of making money in stocks

The chance of stocks dropping in any given 12-month period is about one in four. For five-year periods, the odds drop to one in ten.

But it gets better when we consider that stocks were in a bear market in our immediate past. I compiled some stats on past bear markets in a 2019 post.

On average bear markets last for about 14 months, followed by another 25 months before full recovery. These numbers however were skewed by the three “mega meltdown” bear markets (two recent ones were 2000-02 and 2008-09 periods) during which the stocks dropped by 50% or more. Today’s bear market has been far less punishing. It only declined 25% peak to trough … so far. If we consider this to be a “garden variety” kind of bear market where stocks only drop by 20 to 40% (it also occurs more frequently), average decline period has been 11 months followed by 14 months of recovery.

The 2022 bear market decline lasted about 10 months in total (January through October). So statistically speaking, we could say that full price recovery is expected to take about 14 months.

A garden variety bear markets like today’s takes 14 months to return to its prior high. We are already about 11 months into this recovery period.

To look further into past bear market recoveries, I visited Samantha McLemore blog post from July this year. Ms. McLemore is a disciple of well-known investor Bill Miller and she’s the founder/CIO of Patient Capital Management investment advisor. In her post, History Suggests Continued Market Gains, she compiled data on all prior bear markets to see how stocks fared one and two years after reaching the bottom. See this chart for details.

According to her calculations, both average and median forward returns of year 1, 2, 3, 4, and 5 after entering a bear market have been positive and in double digits. This current bear market appears to follow that historical trend faithfully so far: One year return since the beginning of the bear (June 2022) has been 16%, matching the historic average. As she observed in her piece:

After a bear market, there is no precedent going back over eight decades for negative returns in the second year following a positive first year.

So historical trends appear promising for the next twelve months. However, history ought to be taken with a grain of salt. There is never a guarantee that stocks will follow the same path this time around.

As to my own investing in this period, I had previously shared a table listing all my stock purchases since this downturn began. But all my new money purchases were done last year—none this year so far. This is because I invest when stocks are on the way down, not up. This year, I have only added to some of my existing positions by simultaneously reducing other stock positions. That too was quite infrequent—8 purchases this year versus 45 last year.

I haven’t bought any stocks since June. My last two purchases were both incremental adds to my existing Brookfield Corporation (BN) position. Since then, I have been spending my time just following the companies I own. And investigating some new ones. Disney (DIS) looks appealing at current share price, but I haven’t pulled the trigger on it yet.

Nevertheless, I am quite optimistic about the next 3 — 5-year period. There is a good chance that the stock market will do well in this period, notwithstanding occasional hiccups and volatility. I stay invested.