At the beginning of each year, money managers and financial experts release many predictions around what the forthcoming 12-months will bring from an investing standpoint. But forecasts rarely pan out, particularly in a year as unpredictable as 2021. It is hard, if not impossible, to outguess the market.

So what is the Hill Investment Group take? We expect the US stock market to be up in 2022 between 6-10%. We also predict that the market will most likely not return between 6-10% in 2022.

You probably needed to read that prediction twice, as it seems to contradict itself. Let us explain.

Why do we expect the market to be up between 6-10% in 2022?

That probably seems too simple of a claim given the current market environment. As of the writing of this post, the total US market is at an all-time high; Omicron is spreading rapidly throughout the US, inflation expectations are higher than they have been in decades. Historically, the market has been up, on average, between 6-10% annually. Clearly, with all of these unique circumstances, we can’t expect this year to be like previous years, right?

That is the beauty of the market. Every year is different, and every year the market takes all of these factors into consideration when setting prices. Investors know all of the risks mentioned above, and the current price reflects a fair price for taking on those risks. No matter how you slice the historical data, the market is up about two-thirds of the time, usually between 6-10%. Whether you look at what political party is in office, what inflation expectations are, whether the market had a positive return the previous year, or even if the St. Louis Cardinals made the playoffs…These factors are incorporated into the current price and usually provide investors an expected return roughly between 6-10% over the long term for taking the risk of investing in the equity markets.

Why do we predict that the market most likely will not return between 6-10%?

Although the market, on average over the last roughly 100 years, has returned between 6-10% annually, it rarely returns within that range in any single year. About 1/3rd of the time, the market has had a negative return, about 1/3rd of the time a return between 0-20%, and about 1/3rd of the time a return above 20%. Dating back to 1928, the market has only had a return within two percent of the long-run average four times! Yes…only four times in nearly a century.

This is why we EXPECT the market to return between 6-10% but PREDICT that it most likely will not.

When investing in the stock market, the range of investment returns is much larger than the average return. This is part of what makes investing so hard and why many investors, especially those that choose to do it themselves, get scared and leave the market just when they should likely stay in…or vice versa. It is difficult to see the long-run average when dealing with such volatile swings year to year. However, when you take the long view, embrace our relationship, and think in terms of decades rather than years, you will start to see the benefit and ignore the year-to-year noise and volatility.

Data from Fama/French US Total Market Index

You might have seen articles making equity returns predictions for the next 5, 10, or 20 years. These predictions often forecast dire conditions, which in turn get the reader asking questions like “Is this true?”, “Should I be worried?”, “How should I use this information?” When reading these articles, it’s essential to step back and think about what we can control, what we can’t, and how we should act with that knowledge in mind.

Are these predictions accurate? No one knows. Equity markets are volatile, and the timing or magnitude of returns is tough to predict. Even experts have a terrible track record of reading the tea leaves and investing based on their predictions. Said differently, even those who get it “right” don’t get it right all the way. A common source of error is timing. A famous example is Robert Shiller, credited with “predicting” the 2008 housing market crash with the phrase “irrational exuberance.” The problem? He made that claim in June of 2005, and the market continued to rise for another three years. By the end of 2010, within two years of the crash, global markets on average were once again higher than the June 2005 levels and have remained higher ever since.¹

Should you worry? Since you can’t control near-term future returns, there is little benefit to trying to predict or worrying about them. However, based on the past 100 years or so of market history, we can be generally confident in the long-term future of positive global equity returns. This is because investing in equities involves taking risks, and investors would not take that risk unless they expected some positive return in exchange. Moreover, we know from the past that the range of short-term outcomes will be broad: sometimes positive, sometimes negative. Knowing that short-term results can vary may sound like a bummer, but it can help us build confidence (read on to find out how). 

How can I use this information? Using historical returns, we can determine how much investors, on average, have been compensated for investing in equities over the long term. We can also understand something about the range of possible outcomes over shorter periods. This info is useful when constructing your financial plan. 

At HIG, we can perform an in-depth analysis that includes the financial factors you can control, like saving and spending, and the ones you cannot, like market returns and inflation. Our team uses a sophisticated statistical tool that runs thousands of simulations to determine a range of different potential outcomes for your specific situation. Comparing this range to your goals can give you a sense of your personal “odds of success.” When the analysis shows >85% probability of meeting your goals, we find most clients are comfortable that they are on the right track. The benefit? Confidence. You can focus your time on what’s truly important and ignore the crisis of the month. In other words, we have your back.

If you would like to talk more about this, our CIO office hours are open. Feel free to schedule a 30-minute call.