At the end of each year, it's only natural to reflect: to look back on the past, see where you are now and where you are going. This year I looked back on the S&P (NYSEARCA:SPY), specifically looking at its historic returns and where we are now relative to them. The charts below show the distribution of historic returns for the S&P over a range of time frames.
Each time period shows the minimum and maximum returns earned over that time frame (e.g. looking at the 50 year level shows the maximum return earned over any 50 year period was about $90, the minimum return was about $12 and the median was just over $30). Results are divided into percentiles with the dark blue line representing the best performance for each time frame, the green line representing the worst performance, and the red line showing the median performance, with the light blue and purple lines showing the 25th and 75th percentiles, respectively.
Looking at the chart, several things immediately stand out:
- Over time, the stock market is an enormous creator of wealth with $1 invested turning into more than $15 on average over 40 years, and almost $60 over 60 years.
- Even over long periods of time, the return potential of the stock market varies considerably: over 50 years the stock market has historically turned $1 into anything from $12 to $90. This shows the huge risk involved in retirement planning even for those who have planned well.
- Looking at the same graph in log scale helps to show the market's ability to revert to the mean. Over the first 10 years, the distance between the worst and best performing periods widens considerably to roughly 10 times outperformance before stabilizing and eventually decreasing. This implies that periods with considerable outperformance will likely be followed by periods of underperformance, and vice versa. One nice benefit of this view of the market is that outperformance and underperformance are easily seen as new "record" returns are made, such as in the 2 graphs below.
The graph above adds the backward looking returns made during March 2000 overlaid over the same log scale graph displayed earlier (the black line shows the returns made over the 5, 10, 20, 30, etc. years leading up to March 2000). During this period, the upper bound of the return distribution was pushed upward as new records were made. As we all know the frenzied highs made during the turn of the century were the result of lofty valuations and irrational exuberance and these gains were followed by large losses after. This graph helps to show 2 things:
- First, it demonstrates the ability of this type of graph to highlight high market valuations.
- Second, it helps to show that this sort of graph only shows historic data and future results could potentially fall outside its bounds, especially during periods when the market is valued irrationally.
Similar to the March 2000 graph, the graph above shows the March 2009 period returns overlaid over the same graph. Once again new record levels were made within the graph, only this time new lows were made. Also, similar to the prior graph, this helps to show that if recent results contain a large number of outliers, it can signal that a strong reversion to the mean may occur shortly. That new highs and new lows were both made within the last 13 years helps to highlight the large amount of uncertainty and long-dated volatility in our market. This long-dated volatility can be beneficial to a long-term investor if they use a rebalancing strategy or tactically allocate funds based on valuation, allowing them to sell more equities at high prices and buy more equities at low prices.
The lovely graph above shows our current market returns relative to historic levels, with the rally from the market low in 2009 shifting returns toward the median. Although we are currently setting new lows for the 13 year return, this seems to be largely the result of the high valuations of the dot com bubble and not a result of current market conditions. This leads me to believe that from current levels stock market returns should be in line with the historic average and normal, high single digit returns are likely to be realized over time, despite any future bubbles or market collapses. Despite what appears to be a relatively fair price for the market, it is worth maintaining equity exposure due to the long-term outperformance relative to other asset classes and the historically low yields in bonds.
Disclosure: I do not currently own a direct position in the S&P 500 but I own both long and short positions in various S&P 500 components. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.