This bull market’s strongest gains are behind us.
That’s the conclusion I reached upon analyzing all U.S. bull markets since 1900. The good news is that, assuming the future is like the past, the current bull market still has more months of life in store. The bad news is that the stock market’s gains during those months are likely to be far more modest than what we’ve gotten used to over the last 12 months.
This suggests that we should not extrapolate the last 12 months’ gains into the future.
My analysis takes issue with those analysts who argue that the stock market’s strength over the last 12 months is a bullish omen. In fact there’s nothing particularly unusual about how strong the market was coming off its March 23, 2020, low.
That may seem hard to believe, given that the Dow Jones Industrial Average
gained an incredible 74.4% over the 12 months from that low. But there actually are three other bull markets since 1900 in the calendar maintained by Ned Davis Research in which the Dow rose even more over the 12 months subsequent to their beginnings. The bull market that began following the Great Financial Crisis was not one of those three, but it came close: In the 12 months following the Mar. 9, 2009, low, for example, the DJIA gained 61.4%.
The general pattern is that bull markets typically are strongest right after they’re born: More than half of bull markets’ total gains are produced in their first 12 months, on average. Consider the average bull market in the Ned Davis calendar. Not counting the current one, there were 37 since 1900. Of them, nine—or 24%—didn’t make it to their first birthdays. The remaining 28 lived to be 2.7 years old and during them the DJIA gained a total of 93.9%. If the current bull market is “average,” therefore, it will continue until November of next year—but produce only a modest gain from now until then.
Furthermore, the market’s prospects may actually be more subdued because of its first-12-months strength. That’s because there is a weak inverse correlation between a bull market’s return it its first 12 months and how strong it is thereafter: Bull markets with the strongest first years tend not to last as long, or rise as far, as those bull markets that are slower to take off. (Note that this correlation is statistically weak, however, so you shouldn’t make too much of it.)
What stock market return should you expect going forward?
What future equity return, then, should retirees and near-retirees assume in constructing their financial plans?
The efficient market hypothesis (EMH) tells us that the stock market’s expected return at any given time is independent of what has happened up until that point. That’s because the stock market is a forward-looking, discounting mechanism. So its future return will be a function of whether the future turns out to be better or worse than what is currently anticipated—not by how the market has performed up until now.
The stock market’s has produced an inflation-adjusted total return of 6.0% annualized since 1793, according to research conducted by Edward McQuarrie, a professor emeritus at the Leavey School of Business at Santa Clara University. So if you were agnostic about where we are in the stock market’s cycle, and assuming the future is like the past, that’s the expected return to imbed in your financial plans.
You may not adhere to the EMH, of course. Or you may worry that, since the stock market is overvalued currently according to any of a number of valuation measures, its expected return going forward is lower than average. I share that worry, as I have written in recent columns.
But even if you don’t lower your expected return assumption because of overvaluation concerns, notice that the expected equity return you should include in your financial plan rises only to 6.0% annualized on an inflation- and dividend-adjusted basis. That’s still far short of what the stock market produced over the last 12 months.
Trees don’t grow to the sky, as John Maynard Keynes wrote a century ago. We forget that at our peril.