At this writing on September 8, 2022, the S&P 500 index, a broad, unmanaged basket of U.S. stocks that is frequently used as a proxy for the U.S. equity market, is down roughly 14% year-to-date. Mid-cap and small-cap stocks are also experiencing double-digit losses as is the tech-heavy Nasdaq Composite index. While it’s possible that stocks will rally sufficiently by year-end to move them into positive territory for the year, we don’t think that’s likely based on historical precedent. That being said a Q4 rally, perhaps a strong one, will not be surprising, with markets potentially closing the year higher than they are today. While negative investment returns are obviously uncomfortable and emotionally challenging, the reality is that stocks produce negative returns, on average, one out of every 4.5 years, meaning a year of negative returns isn’t an unusual experience. This begs the question – what usually happens after stock returns are negative in a given year? Does the market usually recover its losses, has it always recovered and, if so, how soon and in what magnitude? To provide some possible insight on these questions based on historical precedent, we reviewed calendar year returns for the S&P 500 index from 1946 through 2021. We identified every negative calendar year during that time then calculated the average annual compound return of the index (including dividends) over the subsequent 3 years following each of those negative years. While historical market performance cannot and should not be used to predict future market results, nor is that the intention of this piece, data such as this might provide a range of possible outcomes and what the next few years might bring.

This is what we found from reviewing the data:

  • From the end of World War II, from 1946 through 2021, stocks produced positive returns in 60 of 76 years and negative returns in 16 of those years, about 21% of the time.
  • The average loss during those 16 years was – 11.60% with – 36.55% being the worst calendar year loss and -1.21% the “best” losing year. 2
  • From 1946 through 2021, the average annual compound return over the 3 calendar years following a negative year was 13.8% with only 1 of those 16 three-year periods producing a negative return (-4.1%, 2001 through 2003). The median return was 14.9%, slightly higher than the average return.
  • The best performing 3-year period following a negative calendar year was a 29.5% annual compound return while the worst performing positive 3-year period was a 3.5% average annual compound return.

As mentioned previously, none of this information is meant to predict future market performance over any particular time period but it does point out that there’s good reason for long term investors to be optimistic after stocks have posted a negative year. Despite what you might see, hear or read from a seemingly never-ending supply of market prognosticators, analysts, chart readers, fortune tellers and others, no one can accurately or reliably predict equity performance over short periods of time. This is one reason why the vast majority of equity fund managers who attempt to time the market fail to outperform the benchmark S&P 500 index over time. While jumping in and out of stocks based on some quantitative or qualitative criteria sounds attractive to some investors, and even somewhat logical, the reality tells a very different story. Market timers almost always fail to outperform “buy and hold” investors who treat equities as long-term investments representing ownership stakes in companies (think Warren Buffet) rather than pieces of paper to be traded like baseball cards (if people still do that – I’m not really sure).

In summary, investing successfully in equities has always required – and will always require – patience, perseverance, discipline and a fundamental understanding that stock ownership represents business ownership. Decades of investing history and data makes a compelling case to remain patient, focused on the long term and allow equities to work as intended, over a full market cycle which is typically 5 to 7 years.

If you have any questions regarding your portfolio, the markets in general, your financial plan or any other issues, please feel free to give us a call or come by the office for a visit. We’re always happy to see you.

As always, thank you for your trust, your confidence and your business. Have a great week.

W. Edward Sutton
President and Chief Investment Officer

The Sutton Wealth Advisors Investment Committee
W. Edward Sutton
Zachary Sutton, CFP®, EA
Derek R. Gage, CFA