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Empirical Study on S&P500 Index
The S&P500 Index delivered a 29% return in 2019. In the last 91 years, the S&P500 Index has given more than 28% returns in a calendar year only 10 times, i.e., only 11% of the time period. The table below shows the frequency distribution.
Trailing 12-month PE of S&P500 Index
The high returns of 2019, the high valuations and the constant rhetoric from the President make one feel nervous about the market direction in 2020. But we present two empirical studies to show that the returns from the S&P500 Index may not be bad even in 2020.
A good year follows a very good year
We took the years in which the S&P500 Index delivered more than 25% returns and tried to see what happens in the next year
* The data is fairly well-distributed with every decade (except 1960s) having at least one year of more than 25% returns and in total there have been 19 such years.
* The average return in the following (next) year is +6.24%.
* If we exclude 1 outlier each from the positive and the negative side, the average return in the following year is +7.69%.
* Out of the 5 instances when the following year has a negative return, 3 instances were prior to 1950.
* If we take the data since 1950, we will have only 2 out of 13 instances as negative return years and the average return increases to 11.25%
We analyzed the returns of the S&P500 Index in the 4th year of the US President’s term.
The negative returns coincide with drastic deterioration in the economy.
* 2008 was the Great Recession
* 2000 was the DotCom bubble burst
* 1932 was the year when US GDP declined by 13% The average return is +11.28%
* Although the rich valuations and the steep run up in the stock prices are a cause of concern, empirical evidence shows that 2020 should also be a year of positive returns.
* This is unless we have a hard landing of the magnitude we saw in 1932/2000/2008.
* We can also defend the empirical analysis by stating that there is a FED put available to the markets and the US has a President who tracks the equity markets closely and frequently tweets about it.
* According to data collected by Charles Schwab, in the past, when inflation has mirrored the levels of today, the price-earnings ratio for the S&P 500 based on future profits has averaged 16.4. While the current multiple is above that now, at 18.6, it is still way below the highest level recorded in a similar low inflation environment, i.e., 23.8.
* Cannot extrapolate this empirical study to India as we have limited data points to draw a statistically significant conclusion.
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