It’s the start of a new year, and investors want answers, especially regarding the stock market and the economy. They want to know how the market will perform this year or if a recession materializes. Market experts, analysts, economists, and media personalities try to predict market moves and the economy’s direction. Yet, it’s a giant guessing game because no one can forecast the future, yet everybody tries to do it.
Last year, twenty-four market analysts predicted the S&P 500 would close at 4,904 in 2022.[1] How did they do? The index closed at 3,389, falling 19.44%, and they missed their target by thirty percent! Despite not knowing the future, the stock market has left several clues about the future of stock prices, and here is what I know.
Stocks Outperform Bonds
Since 1926, the S&P 500 has trounced long-term bonds by a wide margin. A dollar invested in stocks is now worth $11,526, but that same dollar invested in bonds is worth only $130, and one dollar invested in T-Bills barely grew to $22. Over the past decade, the S&P 500 is up 170%, while Vanguard’s Total Bond Market Fund is down 11.3%. It’s impossible to predict the daily or yearly direction of the stock market. Still, over time, it has increased significantly, and you can create generational wealth if you stay invested in stocks and commit to long-term investing.
Small Caps Outperform Large Caps
Good things come in small packages, and this is true for investments. Since 1927, The Dimensional US Small Cap Index has bettered the S&P 500 index. A $1 investment in Dimensional’s Small Cap index is now worth $50,435, while the S&P 500 index value is $10,327. The valuation of the small-cap index has been five times greater than large caps over the past 95 years. The iShares S&P 600 index has been up 529% for the past twenty years, whereas the iShares S&P 500 index is up 362%. Though small-caps have been more volatile than large companies, they produced superior returns.
Diversification Wins
As the saying goes, the only free lunch on Wall Street is diversification. It’s typical for last year’s winners to be this year’s losers. In 2017, international small-cap stocks were the best-performing sector, soaring 32.7%, but a year later, they finished in last place, falling 17.63%, while short-term bonds were the best asset class in 2018; they were the worst in 2019. Large-cap stocks rose 28.7% in 2021 but fell 18.1% in 2022. Emerging markets lost 17.99% in 2022 but are up 10.77% this year. However, a globally diversified portfolio of stocks and bonds stayed in the middle of all asset class returns, never the best nor the worst. Asset allocation accounts for 93.6% of your investment return, and the remaining 6.4% comes from market timing and investment selection.[2]
Now What?
I don’t know what will happen with the market or the economy this year, but your portfolio can grow, over time, if you own stocks in a globally diversified portfolio. Rather than worrying about the direction of markets, interest rates, or the economy, focus on things you can control, like spending and savings.
Forecasts create the mirage that the future is knowable. ~ Peter Bernstein
January 29, 2023
Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on your asset level.
Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.
[1] https://humbledollar.com/2023/01/tune-out-the-noise/ John Yeigh, January 10, 2013
[2] Determinants of Portfolio Performance, Financial Analyst Journal, July/August 1986, Vol 42, No. 4, 6 pages; Gary P. Brinson, L. Randolph Hood, Gilbert L. Beebower.