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  • Writer's pictureRobert Baharian

The Future of The Stock Market

When the market is volatile, investors yearn for stability, and when we have stablily, investors become complacent. The market will give you exactly what you need. And right now, the stock market is teaching you a number of lessons. Some investors will learn lessons from what is unfolding, and most will continue to be flung around like a rag doll.

Throughout the last month, the stock market was down around 6% in the first week, then up over 9% during the remainder of the month. Just because recent performance has been poor doesn’t necessarily mean we’re due for a quick, outsized rally. And it doesn’t necessarily mean that prices should tank further either. It's incredibly difficult predict where the stock market is headed in the short run.

It hasn't been all sunshine and rainbows over the last week in markets, in fact, what's been dominating the news has been the technology sector - getting crushed, with Facebook (Meta) down -28.75%, Amazon down -14.30%, Google down -8.19%, and Microsoft down -6.23%. Yet, the S&P500 was up +1.08% - those silly index investors.

Earlier this month we saw the S&P 500 fall over 25% below its 52-week high, bottomed out on the 12th of October (orange line), and has been rallying since (green line). We've seen these before (blue line), and two weeks of trading isn't really much to go by.

What is far more insightful is the longer-term trend, which has clearly been down. Historically, the larger the drawdown versus 52-week highs, the higher the likelihood that the S&P 500 trades higher one and two years later.

In the charts below, thanks to Bespoke, we show the daily reading in the S&P 500's distance from its 52-week high plotted against the performance of the index one (first chart) and two (second chart) years out from that date. We denote each bear market over those decades with various colored dots whereas dates that fell outside of bear markets are denoted with dark blue dots.

The current drawdown is fairly severe relative to most other bear markets albeit there is precedent for larger declines both inside and outside of bear markets. In other words, this year's drawdown has not necessarily been extreme by some standards. As for what this means in terms of forward returns, historically, more modest declines off of 52-week highs have typically been followed by a wider range of potential performance for the S&P both one and two years out. However, as declines become more extreme, performance has generally leaned more consistently positive.

Source: Bespoke

For drawdowns of 25% or larger (as is the case now), the S&P 500 has historically been higher one year later 93.5% of the time. For the current situation in which the S&P 500 had declined between 25% and 26% from its high, past drawdowns of a similar degree have seen the index higher 80% of the time one year later and 79% of the time two years out.

In their research, Bespoke highlighted the S&P 500 has always offered a positive return over a certain length of time, where there has also been a point at which the drawdowns from 52-week highs have always been followed by positive performance. While the S&P 500 would need to fall back down to levels not seen since the spring of 2020 for this to apply, drawdowns of 34% or larger have historically seen the S&P 500 trade higher one year later 100% of the time. Pivoting to two-year performance, the necessary drawdown for 100% positive performance is slightly more modest at 31%. As always, past performance is no guarantee of future results, but historically speaking, the bigger the S&P drawdown, the more likely it has been to rise going forward.

When markets are volatile as they have been, it's easy to get caught up in all the things that are going right or wrong at the moment. And while there’s nothing wrong with keeping current on the present, this is not the right mindset for long-term investors in stocks.

Legendary investor, Stanley Druckenmiller, says "Do not invest in the present...the present is not what moves the stock prices." Druckenmiller noted that this is his number one piece of advice for new investors.

“I learned this way back in the 70s from my mentor [Speros] Drelles. I was a chemical analyst. When should you buy chemical companies? Traditional Wall Street is when earnings are great. Well, you don't want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there's overcapacity and they're losing money. What about when they're losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it's going to be in 18 to 24 months as opposed to now. If you buy it now, you're buying into every single fad every single moment. Whereas if you envision the future, you're trying to imagine how that might be reflected differently in security prices.”

I don't know what the market is going to do next week, next month, or over the next 6 months. As tempting as marketing timing is, it is fraught with danger. As Druckenmiller says, investors should be focussed on the road ahead, not what happened yesterday or is unfolding today.


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