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Barring a miraculous recovery in the last week of December, the S&P 500 will have finished the year with double-digit losses. As of this writing, it is down ~18%, which would mark the seventh-worst year dating to 1928. Furthermore, it would be the third-worst year since the start of the 21st century!
Despite the bond market improvement over the past two months, 2022 will go down as the most volatile year in history. While this sounds worrisome, many pockets experienced significantly less volatility, which is why we always preach strategic diversification.
The question on investors’ minds now: How will markets perform in 2023? If history is any indication, the answer is better than you may think.
Equities
Dating back to 1928, there have been 20 years where the S&P 500 has lost 10% or greater. Of those instances, only seven times did the S&P follow up with a negative return the following year.
The question is: Will 2023 make it eight? Unfortunately, I don’t have that answer, but we can lean on history to gain some insight.
Source: Macrotrends.
There were significant multi-year drawdowns in the early 1930s (Great Depression) and early 1940s (World War II). But since then, things have been “smoother.” Since 1950, the S&P 500 has experienced only two periods of consecutive or longer annual declines:
1973-1974 (collapse of Bretton Woods and oil crisis)
2000-2002 (dot-com bubble)
That’s it! As bad as markets were in 2008 (Great Financial Crisis), the S&P 500 finished with a 23% gain the following year! In fact, since 1980, the dot-com bubble is the only instance where the index declined for three consecutive years, to the tune of -46.4% during that period.
During the six other instances, the S&P 500 gained an average of ~22.8% the following year:
1981: -9.73%, followed up by a 14.7% gain in 1982
1990: -6.56%, followed up by a 26.3% gain in 1991
1994: -1.54%, followed up by a 34.1% gain in 1995
2008: -38.9%, followed up by a 23.4% gain in 2009
2015: -.73%, followed up by a 9.5% gain in 2016
2018: -6.24%, followed up by a 28.8% gain in 2019
The following-year returns have been pretty stellar. We will find out if 2023 keeps this trend going.
It’s worth noting that while markets didn’t decline for consecutive years during the Great Financial Crisis, the S&P 500 lost 36% in 2008 and another 12% in the first two months of 2009 before embarking on a 42.7% rally for the remainder of the year.
The stock market has evolved over time, and with more people having access to investing than ever before, it does seem that markets tend to rebound faster than ever. However, volatility goes both ways, as witnessed by the multiple 10%-plus declines this year.
Considering the extremely loose monetary policy from central banks for over a decade, we now have the question of what happens moving forward, as the global economy faces the reality of less accommodative central bank policy over the coming years.
Recession?
While we are still dealing with a litany of challenges as we proceed into the new year, we have a few reasons to be cautiously optimistic. I get it—things seem uneasy right now, and the drumbeats for a recession in 2023 are growing louder by the day. There is a good chance we are in the midst of a recessionary period, which would likely be present for a good chunk of 2023.
I can guess what you are thinking: How can we expect the market to sniff out positive returns if we are in a recession come 2023? Well, the reality is, on average, the S&P 500 takes around five to eight months to find a floor during recessions and tends to bottom five months before the end of a recession.
Source: Schroders.
As seen by the chart above, 10 of the last 15 recessions (66.7%) lasted less than one year. On average, markets bottomed roughly five months prior to the recession actually ending!
Let me be clear: Volatility is not going anywhere, and we will likely experience a few more painful months in 2023. But if we use history as our guide, markets will likely turn the corner sooner than we think.
Discuss your situation with a fee-only financial advisor.