Heading into 2015, the general consensus of Wall Street strategists and advisors was that 2015 would be a decent year with the equity market gaining anywhere from five to ten percent. In our 2015 outlook piece, The Bespoke Report, we highlighted the fact that the average year end price targets from fourteen Wall Street strategists for the S&P 500 was a gain of 5.8%. Of those fourteen strategists, none were looking for the market to decline, and more than half were looking for the S&P 500 to rally anywhere between five to ten percent. It’s understandable that no Wall Street strategists were looking for the market to decline. Just as a butcher wouldn’t have signs in his store warning about the unhealthy aspects of meat consumption, if you are in the business of selling stocks, your lead spokesperson should not be telling customers to sell them. Also, by predicting gains, strategists also have history on their sides; going back to 1900 the DJIA has seen positive annual returns two-thirds of the time.
While history supports strategists routinely calling for gains, why do they constantly call for gains in the neighborhood of five to ten percent? Our guess would be that it is a good enough sounding number without really sticking your neck out. At this level, the strategist still sounds bullish enough so that if the market has a big year, he or she can still say, “I told you so.” But if the market goes down, they won’t look too wrong. Also, from a historical perspective, the DJIA’s average annual return since 1900 has been 7.4%, so the range of five to ten percent sounds right around average.
What makes the consensus call for upper single digit gains in the market so interesting is that it rarely happens. For example, going back to 1900 there have only been eight years where the DJIA had an annual gain of between five and ten percent. That works out to just 7% of all occurrences. While the DJIA’s average return since 1900 is 7.4%, there is a lot of variability around that average with a standard deviation of 21.8 percentage points. Strategists would rarely call for a gain or loss of 30% or more in a given year, but based on historical precedent, the frequency of a 30% gain (12 occurrences) is 50% greater than a year where the DJIA sees a gain of between five and ten percent. Similarly, an annual decline of 30% or more (7 occurrences) is nearly as common.
The table below breaks out the frequency of annual returns for the DJIA by a variety of different ranges. Here again, it is really interesting to see that whether the year is up or down, upper single digit returns are the least common of the three different ranges. On the downside, there have been 11 years where the DJIA was down less than 5%, but just five years where it was down between five and ten percent. Similarly, there have been 12 years where the DJIA gained less than 5%, but just eight upper single digit percentage gains. Lastly, while annual gains of between five and ten percent seem uncommon now, ten years ago they were even more rare. As shown in the table to the lower right, of the eight occurrences shown where the DJIA has been up between five and ten percent, four of them have occurred since 2007 with three of them coming in the last four years! Is this the beginning of a new paradigm, or will the volatile nature of the market reassert itself when and if the Fed begins a return to a more normalized rate environment?