Think Markets Are Bad Now? Look Back in Time

Though the stock market has turned upward a bit and inflation has begun to wane, investor sentiment among some clients remains as dismal as a trip to the dentist. Still holding a dour view of the market, they assume (probably incorrectly) that prospects for good returns this year are quite dim.

Never mind that the Nasdaq achieved bull status in mid-August, having risen 20% since June, or that the S&P 500 was up 14.7% during this period. Some clients, still emotionally bruised by negative headlines, just don’t want to hear about it. After being exposed to recession-obsessed media for months, they’re stubbornly pessimistic.

Such sentiments pose a vexing problem for advisors trying to persuade these clients to accept the strategy of taking advantage of still-depressed equity prices. How can advisors show them that their pessimism is counterproductive/? 

The answer may be to take them on a trip back into market history. Clients aware that history often repeats itself (or at least rhymes) might be interested to know that:

Depressing starts to a year have sometimes turned around completely intra-year, even in abysmal social, political and economic conditions. 

In the first half of 1962, the S&P 500 fell 23%, but it increased 15.3% in the second half — and then rose 27% by mid-1963 and 46% by mid-1964. People are complaining about the sad state of the world today, with pandemic lockdowns continuing in China and the war dragging on in Ukraine, but let’s look at things in the early 1960s.

Cold War tensions with the Soviet Union were at a peak (with schoolkids being herded in nuclear bomb drills), race-related riots abounded, a nasty recession had set in, unemployment was astronomical, the top marginal income tax rate was 91% and, in 1963, a popular president was assassinated.

And clients think we’ve got troubles now?

In the first half of 1970, the S&P 500 fell 23%, but rose 27% over the next six months. It then increased 36% by mid-1971 and 47% by mid-1972.

Were things better then than they are now? No way.

Leading up to and during the early 1970s, unemployment was rising, inflation was rapidly ascending (mustering for a prolonged uptrend to double digits), student protests abounded (with four shot dead at Kent State), China tested a nuclear bomb, the Cold War with the Soviet Union was still intense, and Nixon ended the gold standard and imposed a wage-price freeze. The U.S. dollar was devalued. So much for the pressing problems weighing on the market today, when put in historical perspective.

Midterm election years such as 1970 and 2022 have long been more volatile than other years, and most have seen double-digit corrections.

According to Lord Abbett, the average annual drawdown of the S&P 500 in all years from 1980 through 2021 was 14%. In midterm election years, it was 17%. Yet most midterm election year declines have been followed by far greater increases.

Thus, while volatility has been average to low recently, the realization of projected sharp increases in the coming months would not be unusual for such a year. And to the extent that this volatility could bring the market much higher in the last half of 2022, ups and downs wouldn’t seem bad at all. Anyway, they’re just the normal flexing of the market. People who can’t accept volatility really shouldn’t be investing.

According to Strategas Research, from 1950 through 2018, the average market rebound from a midterm year correction, as gauged by the 12-month forward return of the S&P 500, was 32.5% — more than twice the average decline. Every rebound except one (in 1978) was greater than the drawdown that preceded it.

According to BTIG, in these seven decades, when the market declined substantially in a midterm election year, once a rebound made up 50% of the decline, the market has consistently continued to trend upward on average. After retracing 50% of a decline, in none of these rebounds did the S&P 500 subsequently revert enough to test its preceding low. As of Aug. 11, the S&P 500 was trading at 4,253 — a tad over the 50%-retracement point from this year’s decline, 4,230. 

If this remarkably consistent historical pattern holds true this year, the market bottom would have occurred June 17. Assuming this ultimately proves to be the case and the index continues to march upward on average, then the market will have pretty much repeated the poor start/great finish records of many years, including 1962 and 1970, when a lot more bad news came in ensuing years, but the rising market just didn’t care.

Of course, this is history, not science. There’s no law of nature saying that historical patterns will necessarily continue. After all, in this post-pandemic milieu, we’re in a strange market and a weird economy that economists can’t seem to figure out the present of, much less the future.

But a view into the past might dispel assumptions that gloomy or uncertain environments necessarily augur poor equity returns in ensuing months or years, even when a year starts terribly. Hence, dismissing the idea of new investment now probably doesn’t make sense.

Dave Sheaff Gilreath, a certified financial planner, is a founding principal and CIO of Innovative Portfolios, an institutional money management firm, and Sheaff Brock Investment Advisors. Based in Indianapolis, the firms manage assets of about $1.4 billion.