The league batting average for Major League Baseball was .252 in the 2019 season. This means that a player hit the ball and made it safely to base about once in every four at-bats – 25% of the time. For years, the league wide batting average has hovered around this figure. Last season, less than 2% of players hit .300 or better, with no player better than .335. Some players have great months – like Todd Helton who in May 2000 hit .512 – but eventually all end the full season not too far from .250.
“Regression to the mean” is the fancy phrase that describes how measurements gravitate toward their long-term averages over time. A baseball player might be able to hit .500 for a few weeks, but it is a near certainty that his average will decline from there. The same is true for financial markets. Bad years are often erased away by good years; lost decades followed by years of prosperity. Like shards of metal drawn to a magnet, stock market returns have been anchored by the phenomenon of regression to the mean for decades.
Look no further back than last year for proof. After a harrowing end to 2018 that saw the market fall near 20% at its low point, the S&P 500 had its best showing since 2013 while virtually all major stock indexes – domestic and international – advanced more than 20%. Bonds turned in their best year since 2002. The market’s performance defied most experts’ predictions, as things looked bleak at the turn of 2019, and at many times throughout the year. Recession, trade wars and impeachment dominated financial headlines. At its 2019 low, the S&P 500 was down 7% and for the second consecutive year most investors were fleeing stocks for the safety of bonds.
Despite the headwinds and predictions, the market continued its run and rewarded those who stayed invested. The market now has advanced longer than anytime in its history without a 20% decline. Of course, this current run up has not been without hurdles as during this record stretch the S&P 500 has overcome 14 drops of 5%, and 6 drops of at least 10%. Though a decline of 20% was nearly achieved on two occasions, including the 2018 low which saw the market reach a loss of 19.8% on Christmas Eve, we are now approaching the 11-year mark of the current bull market, easily topping the previous record set in the 1990’s which lasted about 9 ½ years.
For the most part, in 2019 the market was primarily supported by an accommodative Federal Reserve (the Fed) who for the first time in over 10 years reduced interest rates three times. To recap, after the financial crisis of 2008 the Fed reduced rates to near zero. Doing so made borrowing costs lower and drove investors to stocks in search of higher returns, in turn lifting prices. The Fed’s low interest rate policy is credited with helping to lift the U.S. out of its worst recession since The Great Depression. Once the economy began to exhibit signs of strength the Fed began lifting rates, and while still historically low, many (including the President) felt as though the Fed went too far in 2018. Once the Fed reversed course with three rate cuts in 2019, the market showed it approval.
A mostly strong economy also provided support to rising stock prices in 2019. Unemployment across all demographics is at 50-year lows and wages are rising faster than the rate of inflation. Household net worth is at an all-time high and the amount that Americans spend to service debt is at a 40-year low. Together these factors helped to ease recession fears that were widespread. Like the stock market, the U.S. economy also broke records in 2019 reaching its longest stretch ever without a recession. Our current economic expansion has now run over 10 years.
Regression to the mean arguably becomes more powerful over time, and as we enter a new decade juxtaposing the past two provides yet more support for the phenomenon. Recall the decade that began in “Y2K” contained two recessions including the worst economic crisis since the Great Depression. That era was also marked with two bear markets that cut stock prices in half each time, including when the S&P 500 fell 57% in 17 months during the financial crisis. It was the worst 10-year period for the S&P 500 ever, including the depression-era 1930’s, and is referred to as “The Lost Decade” because the market finished the decade lower than it began. The Dow Jones Industrial Average ended 2009 at 10,428, having lost over 1,000 points over 10 years.
In 2018 Mike Trout, one of baseball’s best, experienced one of the worst hitting slumps ever, going 19 at-bat’s without a hit. Of course, Mr. Trout eventually bounced back and has since signed 12-year employment contract for $426 million. And just like Mr. Trout, the market over the past decade which began as The Lost Decade ended, bounced back nicely having only one down year. The only other time that stocks were up nine out of ten times over a ten-year span was during the 1980’s and 1990’s, though those decades saw higher returns. In fact, the 2010’s were only the fourth best decade for stock in the last seven. Aside from the 1990’s, the 2010’s have the distinction of being the only decade without a bear market (a decline of 20%) even though we came close in 2011 (down 19.4% at one point) and 2018 (a 19.8% pull back). In addition, the past decade was the first since 1850 without a recession. Technology companies fueled market growth as the combined market capitalization of Apple, Amazon, Microsoft and Google grew from $716 billion to more than $4 trillion.
Like 2019, we begin 2020 facing headwinds. After last year’s surge in stock prices, its hard to argue that a repeat performance is in the cards. With stock valuations a touch above historical averages, further advances will eventually have to be supported by an increase in corporate earnings, which according to FactSet data are expected to grow by 9.55% this year. Either way, stocks and bonds simply do not have as much room to rise this year. Trade negotiations with China continue to drive markets worldwide, with apparent progress being made. Even though research supports that U.S. Presidents have little, if any, influence on long term stock prices, this year’s presidential election is likely to drive volatility, even if election years have historically been kind to stocks (17 of the past 19 election years have produced a positive total return for the S&P 500). But, there’s an impeachment to do deal with first. After reducing rates three times last year, the Fed appears to be on hold for the time being, providing supportive policy for financial markets. Of course, the danger is that markets value assets under the assumption that the Fed will always come to the rescue.
A famous economist once said, “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” Look at Social Security estimates as an example of how difficult predicting the future is. In 1935 when President Franklin D. Roosevelt proposed the Social Security retirement program, his team of experts estimated that total expenditures would reach $1.3 billion in 1980, less than 1% of the actual outlays in 1980 which were $149 billion.
We know that historically that the market (S&P 500) usually produces positive returns. The S&P has been “up” in 15 of the past 17 years. Going back 50 years, the S&P 500 has been “up” 80% of the time, even though the split between “up” and “down” days is nearly even (53% “up” and 47% “down”). Oftentimes, the difference between generating positive returns or a loss is decided by just a few days. Consider an investor who started with $10,000 in the S&P 500 in January 1980. By simply hanging on through December 31, 2018 the $10,000 grew to a tidy sum of $659,591. This time frame including the Lost Decade as well as many other market-shaking events (the Iran hostage crisis, soaring inflation, the Gulf War, etc.) yet the patient investor was rewarded. If that investor’s confidence was shaken such that it caused him/her to panic and sell and miss the 5 best days (only 5 days over a 38-year period!) over $230,000 in growth was missed. Missing 10 of the best days cost the investor more than $340,000. So, rather than ending with $659,591 he/she finished with $318,071. In sum, being on the sidelines has its costs.
Mike Trout isn’t the only great player to fight through a slump. Ted Williams, the last player to hit over .400 in a season (1941) had a 0-for-17 stretch in August 1954. Even the Great Bambino – Babe Ruth – went 21 at-bats without a single hit. Of course, they are now enshrined in the baseball hall of fame, as 28-year-old Mike Trout will one day be. Regression to the mean had just as meaningful of an impact on their abilities to stay on track during their rough patches as it does to an investor saving for retirement. We can’t know what this next decade will have in store for us, but the differences in the past two validates the axiom that time in the market is better than timing the market.
Written by Robert C. Votruba, Ph.D., Director of Investments, National Financial Network LLC. Registered Principal and Financial Advisor of Park Avenue Securities LLC (PAS), 990 Stewart Avenue, Suite 200. Garden City, NY 11530. Securities products and advisory services are offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America (Guardian), New York, NY. PAS is an indirect, wholly owned subsidiary of Guardian. National Financial Network LLC is not an affiliate or subsidiary of PAS or Guardian.
Opinions expressed herein are not necessarily those of Guardian or Park Avenue Securities. Data and rates used were indicative of market conditions as of the date shown. Opinions, estimates, forecasts, and statements of financial market trends are based on current market conditions and are subject to change without notice. References to specific securities, asset classes and financial markets are for illustrative purposes only and do not constitute a solicitation, offer, or recommendation to purchase or sell a security.
Data Source: FactSet
S&P 500 Index is a market index generally considered representative of the stock market as a whole. The index focuses on the large-cap segment of the
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The S&P MidCap 400 provides investors with a benchmark for mid-sized companies. The index seeks to remain an accurate measure of mid-sized companies, reflecting the risk and return characteristics of the broader mid-cap universe on an on-going basis. The Wilshire 5000 Total Market Index represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data.
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Sources: Wall Street Journal, Barron’s, Commerce Department, Bloomberg, Federal Reserve, Fortune, JP Morgan, National Bureau of Economics.
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