After a banner 2023, the market faces a tough challenge for a repeat performance

Published Tue, Jan 2 20248:31 AM ESTUpdated Tue, Jan 2 202411:24 AM EST

What happens after the S & P 500 goes up 20% or more in a year? Here's one surprise: Such gains happen fairly often. Since 1928, the S & P 500 has finished up 20% or more about 36% of the time. Flip that around: Declines of 20% are very rare. Yes, 2022 was down about 19%, but the S & P has posted declines of 10% or more only 12% of the time since 1928. S & P 500 (percentage advance each year) 20%+ advance 36% 10%–20% advance 21% 0%–10% advance 15% 0%–10% decline 15% 10%+ decline 12% Source: Dimensional Funds The simple fact that the S & P 500 goes up three out of four years is one of the reasons indexing has proven to be such a strong investing methodology. So what happens after a 20% gain? My friend, Ben Carlson, director of institutional asset management at Ritholtz Wealth Management, a great market watcher, noted recently that the stock market was up 22 out of the 34 years following a 20% gain (65% of the time). What happens after a 20% up year? Up: 65% Down: 35% Average return: 8.9% Average gain in up years: 18.8% Average loss in down year: 9.1% Source: A Wealth of Common Sense Note that the returns following a 20% gain are fairly widely dispersed. In years when the S & P 500 is up following an up 20% year, the average gain is 18.8%. But in years when it is down, in the following year, the average decline is 9.1%. What happens in January after a 20% gain? Januarys are a little less interesting in years following a 20% up year. Jessica Rabe, co-founder of DataTrek Research, noted that since 1958, the S & P 500 was down 0.2% in January following an up 20% year, but the range of outcomes was also very wide. It was higher only 48% of the time. Rabe's conclusion: "When the S & P has a strong year (+20 pct), it's a coin flip as to whether the index will also rally in the following January." Could the S & P gain 20% again in 2024? While we are busy torturing the historic data, how about this: How often does the S & P 500 see back-to-back gains of 20%? Pretty rarely. Nicholas Colas, also a co-founder at DataTrek, notes that since 1928, the S & P has seen back-to-back gains of 20% just nine times. That's 10% in 95 years. Those years were 1935-36, 1950-51, 1954-55, 1975-76, 1982-83, 1995-96, 1996-97, 1997-98, and 1998-99. That run from 1995 to 1999 was certainly epic, but that was the last time the S & P 500 saw back-to-back 20% gains. Regardless, with the S & P 500 closing the year at 4,769, a 20% gain next year would mean the S & P would hit 5,722. That is far more than the most optimistic Wall Street strategists. The two highest estimates are Tom Lee, head of research at Fundstrat Global Advisors, and John Stoltzfus, chief investment strategist at Oppenheimer Asset Management, both at 5,200. How likely is it to hit a second up 20% year? Colas notes that it could happen, "but it requires that everything go exactly right. The US/global economy cannot stumble, and nor can corporate earnings. Interest rates must continue to decline. Gen AI must prove its worth and drive investor confidence to similar levels as we saw in the late 1990s." That's a tall order, and Colas knows it. "All this is possible," he said. "It is not, however, our base case."