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The current bull market turned three in early October. What’s remarkable is that once again, almost no one saw this one coming.
While it feels like a lifetime ago, September 2022 looked pretty bleak, with the Consumer Price Index (CPI) registering at 8.2%. While slightly lower than the ~9.1% reading in June, consumers were feeling the pain of inflation, which was not subsiding quickly enough. This, in turn, led to turmoil in the bond and equity markets, with losses ranging from -15% to -28%. It felt like there was nowhere to hide, and even gold, which generally serves as a hedge against market volatility, declined 9%.
Then it happened: Markets started rallying in October without any defined catalysts. And minus a few hectic months, markets haven’t looked back since. The returns for bonds and equities have been between +20% and +93%!
Barring a monumental collapse in the last two months of the year, the S&P 500 is on pace for its third straight year of gains. As mentioned, this rally commenced in October of 2022, and to be honest, if someone had told me then that the S&P 500 was about to rally ~93%, I likely would have had a good laugh. In this case, the joke would have been on me! My commentary this month will look into the past to see what trends, if any, generally follow rallies of this duration. While there are no guarantees in investing, history can oftentimes provide us with a range of expected outcomes.
Dating back to 1928, this will be the 12th instance of the S&P index rising for three consecutive years. The average cumulative return across this period is ~64%, which is almost exactly where we are today with two months left in the year. What’s even more impressive is that this is likely to be just the fourth time in which all three years garnered a return north of 10%.*
In looking at the 11 other instances of the S&P rising for three consecutive years, the returns in the fourth year have been somewhat mixed. In six of the 11 instances, the S&P yielded a positive return, while in the other five, it yielded a negative return.
The average return for all year-four outcomes is +6.7%.
The average positive year-four return is +21.80% (four-year win streak).
The average negative year-four return is -11.50% (three-year win streaks ends).
Looking at the bigger picture, the S&P has yielded a positive total return in ~70% of the years over the past century. Some may conclude that the odds are much less favorable in this fourth-year scenario, but, as we know by now, markets are not that cut-and-dry.
As seen on the chart below, returns in year four have ranged from -18% to +35.8%. While that alone doesn’t tell us much, in seven of the 11 years, the returns have been between -10% and +15%, which, historically speaking, is a common outcome.
Source: Blue Haven Capital.
The worry for many is a crash in 2026, as markets continue to rally in the face of so much economic uncertainty. The truth is, when markets rally under these conditions, the talk of a crash grows louder and louder. Thankfully, these voices tend to be wrong. As we know by now, trying to time markets is a fool's errand, and most who attempt it end up with a significantly lower return than those who ride out the volatility. With that said, this is an ideal time to reconfirm your risk tolerance, rebalance where necessary, and take profits for any cash flow needs in 2026.
Now, it’s important to put things in context. A market correction, defined as a drop of at least 10% but less than 20%, generally takes place every one to two years and should be expected for those with a higher percentage (75%+) exposure to equities. A bear market, on the other hand, is defined by a drop of at least 20% and is, thankfully, rarer, happening 27 times since 1928. That shakes out to once every ~3.8 years. Since 1945, there have only been 15, which is one every ~5.1 years.
Losses of this magnitude are not to be taken lightly, especially for those who are retired or approaching retirement. Investors in those scenarios should have a proper mix of equities, bonds, and cash to help cushion the volatility. Case in point, those invested in a 60% equity/40% bond portfolio have experienced a bear market only once in every ~13.6 years!
Getting back to 2026: History tells us that year four is, by and large, no different than any other year. Investors should, however, adjust their expectations. The past three years have been remarkable, given the extreme levels of uncertainty. Markets may continue to grind higher over the coming years, but expectations should be adjusted, and there’s no shame in taking some profits in a bull market!
Feel free to discuss your situation with our financial planning firm.
* The S&P 500 is up 15.5% as of the writing of this commentary.
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