The Stats Speak for Themselves
People often ask, ‘What’s next for the stock market?’ and the honest answer is – it’s impossible to know.
Research and analytics allow us to create a picture around the most probable scenarios, but the irrational short-term moves are impossible to predict. There is an endless list of unknown unknowns to consider. Claiming you know exactly what’s around the corner is naivety, not intelligence.
But the thing is, you don’t need to know what’s next.
It’s Not as ‘Risky’ as You Think
On a daily basis, stocks are up 53% of the time – little better than a coin toss. Not exactly the guaranteed odds you’re looking for when investing your life savings.
This short-term uncertainty has often acted as a deterrent for investors but let’s zoom out a bit and look at the bigger picture.
History has shown the longer the holding period, the greater the probability of positive returns.
On an annualized basis, the S&P 500 has returned positive returns in 70 of its 94 years, producing positive annual returns 74% of the time.
The further you extend this timeline, the greater the probability of positive performance. Rolling 10-year returns have been positive 92% of the time, while rolling 14-year returns have been positive 100% of the time.
Probability of a Lower S&P 500 by Number of Years Invested
Simply put, the longer you stay invested, the lower the probability of losing money. There has been no 14-year or longer period when the S&P 500 has declined in value, and that is even before counting dividends.
Statistically speaking, for long-term investors, the probability of success sits firmly in your favour.
Stocks Go Where Profits Go
With that said, just because stocks have gone up in the past doesn’t mean this is guaranteed to happen in the future.
But it’s not like the stock market has gone up for no reason. The stock market has historically gone up because the profits made by the companies that make up the stock market have increased.
To quote the legendary investor Peter Lynch:
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. So, I think — the market is about 3,800 today, or 3,700 — I’m pretty convinced the next 3,800 points will be up; it won’t be down. The next 500 points, the next 600 points — I don’t know which way they’ll go. So, the market ought to double in the next eight or nine years. 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.
He said this in 1994 in reference to the Dow Jones Industrial Average which was 3,797 at the time. 28.5 years later it is 33,500. this represents an annual growth rate of almost exactly 8%. Pretty remarkable stuff.
You will never be able to predict the exact path forward for stocks, prices will fluctuate in the short term, but markets will trend higher over time in line with earnings growth. In other words, stocks go where profits go.
If you believe that companies will continue to innovate and find new ways to generate profits over time, you need to allocate a portion of your future earnings to these companies. It really is that simple.