Expecting average returns doesn't mean you should expect average years 🤔
Expecting average returns doesn't mean you should expect average years 🤔
Plus a charted review of the macro crosscurrents 🔀
Stocks rallied last week with the S&P 500 climbing 2.7% to close at 5,099.96. It was the best one-week gain since November. The index is now up 6.9% year to date and up 42.6% from its October 12, 2022 closing low of 3,577.03. For more on market volatility, read: Even strong stock market years can get very stressful 😱
History teaches us that the stock market generates average annual returns of 8-10%. And so it’s perfectly natural for investors to form expectations that prices will mostly trend steadily higher throughout any given year.
But it can also be unsettling to watch the market track significantly below or above the path that gets you to that average return — kind of like what you see below in this chart from Ritholtz Wealth Management’s Ben Carlson, which shows the average one-year price path of the S&P 500 since 1950.
As Carlson astutely notes, “if you look at the individual years that make up this average, the range of results are all over the place.“
He offered a second chart plotting all the one-year paths of the S&P since 1950.
“There is no such thing as an ‘average’ year in the stock market,” Carlson wrote.
All of this echoes TKer Stock Market Truth No. 3: Don’t ever expect average. (In fact, when I published 10 Truths About The Stock Market in October 2021, I used one of Carlson’s charts to illustrate the point. Subscribe to his newsletter!)
Zooming out 🔭
It’s fair to expect average annual returns over the lifetime of your investment in the stock market.
But don’t expect average returns for each individual year. That would set you up to be overly disappointed in below-average years, and perhaps overly worried about froth in above-average years.
Best to be mindful of the fact that average returns are only realized after combining multiple years of performance, which will include some below-average years and above-average years.
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Related from TKer:
Reviewing the macro crosscurrents 🔀
There were a few notable data points and macroeconomic developments from last week to consider:
🎈 Inflation trends need to cool more. The personal consumption expenditures (PCE) price index in March was up 2.7% from a year ago, up from February’s 2.5% rate. The core PCE price index — the Federal Reserve’s preferred measure of inflation — was up 2.8% during the month, matching the lowest print since March 2021.
On a month over month basis, the core PCE price index was up 0.3%, unchanged from the previous month. If you annualized the rolling three-month and six-month figures, the core PCE price index was up 4.4% and 3.0%, respectively.
Inflation rates have a little more to go to get to the Federal Reserve’s target rate of 2%, which is why the central bank continues to indicate that it wants more data before it is confident that inflation is under control. So even though there may not be more rate hikes and rate cuts may be around the corner, rates are likely to be kept high for a while.
For more on inflation, read: Inflation: Is the worst behind us? 🎈and 'Check yourself' as the data zig zags ↯
🛍️ Consumers are spending. According to BEA data, personal consumption expenditures increased 0.8% month over month in March to a record annual rate of $19.35 trillion.
Adjusted for inflation, real personal consumption expenditures increased by 0.5%.
For more on what’s bolstering personal consumption activity, read: Unsettling stats about consumer health are missing the bigger picture 💵
💳 Card data suggests spending is holding up. From JPMorgan: “As of 19 Apr 2024, our Chase Consumer Card spending data (unadjusted) was 0.7% above the same day last year. Based on the Chase Consumer Card data through 19 Apr 2024, our estimate of the U.S. Census April control measure of retail sales m/m is 0.34%.“
From Bank of America: “Total card spending per HH was down 0.5% y/y in the week ending Apr 20, according to BAC aggregated credit & debit card data. Retail ex auto spending per HH came in at -0.6% y/y in the week ending Apr 20.”
For more on consumer finances, read: Unsettling stats about consumer health are missing the bigger picture 💵 and Consumer finances are somewhere between 'strong' and 'normal' 💰
⛽️ Gas prices fall. From AAA: “With domestic gasoline demand decidedly in the doldrums and the cost of oil retreating, the national average dipped two cents since last week to $3.65. … According to new data from the Energy Information Administration (EIA), gas demand fell from 8.66 to 8.42 million b/d last week. Meanwhile, total domestic gasoline stocks decreased by .6 million bbl to 226.7 million bbl. Lower demand and a drop in oil prices could push pump prices lower.”
For more on energy prices, read: Higher oil prices meant something different in the past 🛢️
💼 Unemployment claims tick lower. Initial claims for unemployment benefits declined to 207,000 during the week ending April 20, down from 212,000 the week prior. While this is above the September 2022 low of 187,000, it continues to trend at levels historically associated with economic growth.
For more, read: Labor market: How cool will it get? 🥶
🤷🏻♂️ Consumer vibes recovery takes a breather. From the University of Michigan’s April Surveys of Consumers: “Consumer sentiment continued to plateau and was virtually unchanged for the third month in a row. … Different parts of the population exhibited offsetting changes this month. Republicans posted notable declines in sentiment this month, whereas Democrats and Independents did not. Sentiment for younger consumers rose, in contrast to middle-aged and older adults whose sentiment changed little or fell. Overall, consumers continue to express uncertainty about the future trajectory of the economy pending the outcomes of the upcoming election, but at this time there is no evidence that global geopolitical factors are on the forefront of consumers' minds.”
For more on improving sentiment, read: The economic vibes are healing 😀
🏠 Mortgage rates rise. According to Freddie Mac, the average 30-year fixed-rate mortgage rose to 7.17% from 7.1% the week prior. From Freddie Mac: “Mortgage rates continued rising this week. Despite rates increasing more than half a percent since the first week of the year, purchase demand remains steady. With rates staying higher for longer, many homebuyers are adjusting, as evidenced by this week’s report that sales of newly built homes saw the biggest increase since December 2022.”
For more on mortgages and home prices, read: Why home prices and rents are creating all sorts of confusion about inflation 😖
👍 Many homeowners are free and clear of mortgages. According to Census data cited by ResiClub, around 39% of homeowners are mortgage-free — meaning they own their homes outright.
There are 146 million housing units in the U.S., of which 86 million are owner-occupied. As noted above, 39% are free and clear. Of those carrying mortgage debt, almost all have fixed-rate mortgages, and most of those mortgages have rates that were locked in before rates surged. All of this is to say: Most homeowners are not particularly sensitive to movements in home prices or mortgage rates.
For more, read: Why home prices and rents are creating all sorts of confusion about inflation 😖
🏘️ New home sales rise. Sales of newly built homes rose 8.8% in March to an annualized rate of 693,000 units.
For more on housing, read: The U.S. housing market has gone cold 🥶
👍 Activity survey signals growth, albeit slowing growth. From S&P Global’s April Flash U.S. PMI: “The U.S. economic upturn lost momentum at the start of the second quarter, with the flash PMI survey respondents reporting below-trend business activity growth in April. Further pace may be lost in the coming months, as April saw inflows of new business fall for the first time in six months and firms’ future output expectations slipped to a five-month low amid heightened concern about the outlook.”
It’s worth remembering that soft data like the PMI surveys don’t necessarily reflect what’s actually going on in the economy, especially during times of stress.
For more on this, read: What businesses do > what businesses say 🙊
👍 Business investment activity is up. Orders for nondefense capital goods excluding aircraft — a.k.a. core capex or business investment — grew 0.2% to $73.85 billion in March.
Core capex orders are a leading indicator, meaning they foretell economic activity down the road. While the growth rate has leveled off a bit, they continue to signal economic strength in the months to come.
For more, read: The economy has gone from very hot to pretty good 😎 and 'Check yourself' as the data zig zags ↯
🇺🇸 The economy cooled in Q1. According to preliminary Bureau of Economic Analysis data released on Thursday, U.S. GDP grew at an annual rate of 1.6% in Q1. This is down significantly from the 3.4% rate in Q4. Much of the slowdown can be explained by a rise in net exports, which subtracted 0.9 percentage points from GDP.
Because the way GDP is calculated includes a lot of these weird quirks, economists will often point to “final sales to private domestic purchasers” to get a better sense of the underlying health of the economy. This metric excludes net exports, inventory adjustments, and government spending. That metric grew at a 3.1% rate in Q1, down modestly from the 3.3% rate in Q4.
For more, read: How U.S. economic strength was a drag on Q1 GDP 🤯
🇺🇸 Most U.S. states are still growing. From the Philly Fed’s March State Coincident Indexes report: "Over the past three months, the indexes increased in 44 states, decreased in five states, and remained stable in one, for a three-month diffusion index of 78. Additionally, in the past month, the indexes increased in 41 states, decreased in two states, and remained stable in seven, for a one-month diffusion index of 78.”
📈 Near-term GDP growth estimates look good. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 3.9% rate in Q2.
For more on economic growth, read: Economic growth: Slowdown, recession, or something else? 🇺🇸
Putting it all together 🤔
We continue to get evidence that we are experiencing a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
This comes as the Federal Reserve continues to employ very tight monetary policy in its ongoing effort to get inflation under control. While it’s true that the Fed has taken a less hawkish tone in 2023 and 2024 than in 2022, and that most economists agree that the final interest rate hike of the cycle has either already happened, inflation still has to stay cool for a little while before the central bank is comfortable with price stability.
So we should expect the central bank to keep monetary policy tight, which means we should be prepared for relatively tight financial conditions (e.g., higher interest rates, tighter lending standards, and lower stock valuations) to linger. All this means monetary policy will be unfriendly to markets for the time being, and the risk the economy slips into a recession will be relatively elevated.
At the same time, we also know that stocks are discounting mechanisms — meaning that prices will have bottomed before the Fed signals a major dovish turn in monetary policy.
Also, it’s important to remember that while recession risks may be elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs, and those with jobs are getting raises.
Similarly, business finances are healthy as many corporations locked in low interest rates on their debt in recent years. Even as the threat of higher debt servicing costs looms, elevated profit margins give corporations room to absorb higher costs.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have recently had some bumpy years, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the the previous TKer macro crosscurrents »
TKer’s best insights about the stock market 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters about the stock market. All of the headlines are hyperlinked to the archived pieces.
10 truths about the stock market 📈
The stock market can be an intimidating place: It’s real money on the line, there’s an overwhelming amount of information, and people have lost fortunes in it very quickly. But it’s also a place where thoughtful investors have long accumulated a lot of wealth. The primary difference between those two outlooks is related to misconceptions about the stock market that can lead people to make poor investment decisions.
The makeup of the S&P 500 is constantly changing 🔀
Passive investing is a concept usually associated with buying and holding a fund that tracks an index. And no passive investment strategy has attracted as much attention as buying an S&P 500 index fund. However, the S&P 500 — an index of 500 of the largest U.S. companies — is anything but a static set of 500 stocks.
The key driver of stock prices: Earnings💰
For investors, anything you can ever learn about a company matters only if it also tells you something about earnings. That’s because long-term moves in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. Over time, the relationship between stock prices and earnings have a very tight statistical relationship.
Stomach-churning stock market sell-offs are normal🎢
Investors should always be mentally prepared for some big sell-offs in the stock market. It’s part of the deal when you invest in an asset class that is sensitive to the constant flow of good and bad news. Since 1950, the S&P 500 has seen an average annual max drawdown (i.e., the biggest intra-year sell-off) of 14%.
High and rising interest rates don't spell doom for stocks👍
Generally speaking, rising interest rates are not welcome news for the economy and the stock market. They represent higher financing costs for businesses and consumers. All other things being equal, rising rates represent a hindrance to growth. However, the world is complicated, and this narrative comes with a lot of nuance. One big counterintuitive piece to this narrative is that historically, stocks have actually performed well during periods of rising interest rates.
How stocks performed when the yield curve inverted ⚠️
There’ve been lots of talk about the “yield curve inversion,” with media outlets playing up that this bond market phenomenon may be signaling a recession. Admittedly, yield curve inversions have a pretty good track record of being followed by recessions, and recessions usually come with significant market sell-offs. But experts also caution against concluding that inverted yield curves are bulletproof leading indicators.
How the stock market performed around recessions 📉📈
Every recession in history was different. And the range of stock performance around them varied greatly. There are two things worth noting. First, recessions have always been accompanied by a significant drawdown in stock prices. Second, the stock market bottomed and inflected upward long before recessions ended.
In the stock market, time pays ⏳
Since 1928, the S&P 500 generated a positive total return more than 89% of the time over all five-year periods. Those are pretty good odds. When you extend the timeframe to 20 years, you’ll see that there’s never been a period where the S&P 500 didn’t generate a positive return.
What a strong dollar means for stocks 👑
While a strong dollar may be great news for Americans vacationing abroad and U.S. businesses importing goods from overseas, it’s a headwind for multinational U.S.-based corporations doing business in non-U.S. markets.
Economy ≠ Stock Market 🤷♂️
The stock market sorta reflects the economy. But also, not really. The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.
Stanley Druckenmiller's No. 1 piece of advice for novice investors 🧐
…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.
Peter Lynch made a remarkably prescient market observation in 1994 🎯
Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.
Warren Buffett's 'fourth law of motion' 📉
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
Most pros can’t beat the market 🥊
According to S&P Dow Jones Indices (SPDJI), 59.7% of U.S. large-cap equity fund managers underperformed the S&P 500 in 2023. As you stretch the time horizon, the numbers get even more dismal. Over a three-year period, 79.8% underperformed. Over a 10-year period, 87.4% underperformed. And over a 20-year period, 93% underperformed. This 2023 performance follows 13 consecutive years in which the majority of fund managers in this category have lagged the index.
The sobering stats behind 'past performance is no guarantee of future results' 📊
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. For example, 318 large-cap equity funds were in the top half of performance in 2020. Of those funds, 39% came in the top half again in 2021, and just 5% were able to extend that streak through 2022. If you set the bar even higher and consider those in the top quartile of performance, just 7% of 156 large-cap funds remained in the top quartile in 2021. No large-cap funds were able to stay in the top quartile for the three consecutive years ending in 2022.
The odds are stacked against stock pickers 🎲
Picking stocks in an attempt to beat market averages is an incredibly challenging and sometimes money-losing effort. In fact, most professional stock pickers aren’t able to do this on a consistent basis. One of the reasons for this is that most stocks don’t deliver above-average returns. According to S&P Dow Jones Indices, only 24% of the stocks in the S&P 500 outperformed the average stock’s return from 2000 to 2022. Over this period, the average return on an S&P 500 stock was 390%, while the median stock rose by just 93%.
Great write up 👍