It is easy to lose enthusiasm for stock market investing when markets are volatile and returns are disappointing. It is made worse when the press only reports doomsday headlines. If recent past performance is making you question your participation in the stock market, remember that what happened in the recent past has no predictive power over the near future.
A study of the 2008 US stock market, the second worst year in its history when it fell 38.3%, conducted by a researcher at Dimensional Fund Advisors asks: Does the stock market performance in 2008 provide any information about future stock returns? Can the poor returns from 2008 be expected to persist or might the market revert to good performance? Does volatility persist or die out quickly?
The study found that the stock market decline and volatility of 2008 provided no additional insight into what the return for 2009 was likely to be, and that, if the past is any guide, at least some of the volatility of 2008 was likely to spill over into the next year.
Because financial markets are forward looking, it is natural for investors to form expectations about the immediate future and beyond. It might be frustrating that the analysis makes no statements about what those expectations should be, but the results are valuable because they tell us something about how not to form those expectations. In particular, trying to forecast what is likely to happen the rest of this year is probably a waste of time, just as it was in 2009.
Expected returns and risk estimates must be based on a much larger information set, but, just for the record, the US market returned 31% in 2009.
Notes: The study this piece refers to is “Some Historical Perspective on 2008”, by Jim Davis, Vice President at Dimensional Fund Advisors. He uses CRSP Value-Weighted Index, provided by the Center for Research in Security Prices at the University of Chicago, as the representative of the US market throughout the study. The 2009 figure uses the same index.