What follows low returns?
This year’s pandemic-induced sell-off reduced the S&P 500 Index’s trailing five-year compound annual growth rate (CAGR) to just 3.7% at the close of trading on March 24, 2020, down from 12.0% on January 31. That’s a dramatic change for a five-year statistic, and we wanted to know what history said about other times when the trailing return was similarly low.
We looked at monthly rolling five- and ten-year CAGRs for the S&P 500 Index going back to 1905.¹ Why 1905? We felt it was important to include boom times such as the 1920s, busts such as the Great Depression, and all the wars, inflation, deflation, political turmoil, and other events that have knocked the stock market off its course along the way.
The first thing we observed was that a trailing five-year return of 3.7% or less is rare. The S&P 500 Index has delivered that low a return only 309 times out of the 1,373 rolling five-year periods since 1905. The average five-year CAGR across all 1,373 periods is 9.8%, and the average ten-year CAGR is nearly as high, at 9.6%.
However, when we isolated the returns that followed times such as today—when the trailing five-year return was 3.7% or lower— the subsequent five- and ten-year CAGRs were much higher than average, at 11.2% and 10.7%, respectively.
In fact, in 94% of cases that followed a low-return environment, the next five years saw a positive CAGR, while the next ten years were positive 100% of the time.
Not a fluke
We looked at how often returns were strongly positive following a low-return period in order to determine whether a few powerful rebounds had skewed the averages. What we found was that in 82% of cases, the five-year return was a CAGR in excess of 5%, compared with 72% of all rolling five-year returns having a CAGR greater than 5%. The subsequent ten-year results were even more consistent, with 96% of cases delivering a return greater than 5%, versus 79% of all rolling ten-year periods.
Finally, we looked at the worst-case scenarios—the lowest five- and ten-year CAGRs following a period of low returns—to assess how often investors may have been enticed by low stock prices only to see the market go much lower. Here, too, the results were encouraging. The worst five-year CAGR to come on the heels of a 3.7% or lower five-year return was –6.6%. The worst five-year period on record was nearly three times as bad: –18%. The worst ten-year CAGR following a period of low returns was actually a positive number—2.4%—compared with a –5.5% CAGR for the worst ten-year period since 1905.
What history tells us
We believe our research shows there’s a clear pattern of strong returns following weak returns, that, in most cases, when the market has registered a five-year trailing return as low as the current one, it’s gone on to deliver above-average returns over the next five to ten years. These subsequent returns have been shown to be consistently strong, with even the worst-case examples far better than the worst case for the entire dataset. While past performance does not guarantee future results, history suggests that now may be a good time for long-term investors to add to their equity exposure.
1 Standard & Poor’s, data was run from November 30, 1905, to March 24, 2020. The S&P 500 Index tracks the performance of 500 of the largest publicly traded companies in the United States. It is not possible to invest directly in an index.
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