It’s been five years since the bottom of the market. The S&P 500 fell to an intraday low of 666 points on March 9th, 2009. The ride since has been incredible. The market has climbed 25% per year since then, incredible returns that no one was predicting back then.
Twenty-five percent annualized returns over a five-year period are astounding, which had us wondering if there had ever been other five-year periods with such high returns. After running the numbers back to 1926, we found 23 other five-year periods that had annualized trailing returns of more than 25% per year. Twenty-three! Keep in mind that’s out of 975 rolling five-year periods since 1926. Ninety-eight percent of all five-year periods have been less than what we just experienced. There is little question that we are statistically out on the upper fringe of one of the strongest bull markets in history.
We’re firm believers in a concept called “regression to the mean,” which is a fancy way of saying, “what goes up must come back down.” Periods of excessive high returns tend to lead toward the next period having below-average returns. The same holds true during bad markets. Think of March 2009 as the market was bottoming. Even though no one was saying it, it was reasonable to assume the laws of economic balances would take hold and move toward average returns at least.
So what actually happened during the five years following each of the 23 periods that had higher returns than we’ve just experienced? Did “reversion to the mean” hold true? The answer is, “kind of.” Eight high-return periods posted what I’d consider to be average returns over the following five years. Returns ranged from 8% to 11% over the next five years. But 15 of the 23 periods had well-below-average returns over the next five years, ranging from down 1% to down 13% per year. With two-thirds of past experiences leading to negative returns in the future, a note of caution is certainly warranted in today’s market.
Just in case you’re wondering, the best five-year stock market return was posted in 1937, coming off of the bottom of the Great Depression. As of May of 1937, the S&P 500 had returned 29.47% over the previous five years. Will we get there and maybe even set a new record in the current bull market? If we avoid the 12.9% annual loss over the five years following May 1937, I’ll be OK with not setting the record.