If History Is Our Guide, Stocks Could Rally 20% In 2018

We have written extensively on the strength of this bull market.

For the only the second time since 1929, the maximum drawdown on the S&P was less than 3%

Put it like this, had bought and then sold at the worst possible times last year, you would have lost a measly 2.8%.

And right now, stocks don’t appear to be slowing down.

The S&P 500 has already popped 6% this year, but can this ‘melt-up’ continue?

With the help of some top-notch analysts, we are going looking at what has happened after calendar years in which investors may have forgotten what it’s like to lose a few trades.

Stocks After Enormous Years

Using closing prices on the index, the table below shows the years with the smallest drawdowns on the S&P.

Only 1995 had a smaller maximum drawdown than last year; therefore, if 1996 is an apt comparison to right now, then investors will be very happy.

The S&P 500 went up more than 140% over the next four years, for an annualized return of nearly 25%, before the tech boom finally topped out.

So, even after a full calendar year of only new highs, it does not mean a pullback is imminent.

SPX Drawdowns Chart 1

However, such a solid year does not always lead to outsized returns going forward.

The next table summarizes the S&P 500 returns following the years listed above.

Stocks tended to struggle over the next six months, with the index averaging a slight loss, and just half of the returns positive.

In other years since 1950, the S&P averaged a 4.57% return in the first half of the year, with over 70% of the returns positive.

After these slow starts, though, stocks seem to recover some.

The full-year returns following small-drawdown years is close to the full-year returns during other years — at least when looking at the averages.

SPX Year After Chart 2

If History Repeats, Stocks Could Run Another 20%

Below is a chart showing the returns of the subsequent years from the list above.

I also included this year so far, alongside a line showing the average.

The returns are wide ranging. The S&P 500 fell more than 25% in 1962, before recovering some to finish the year down just over 10%.

So, it’s not implausible for this market to take a turn for the worse.

However, two of the years finished with gains of more than 20%.

Of these years, 2018 is off to the fastest start yet.

The SPX is up over 6%, and we’re not even through the first month.

The only year comparable to that is 1996, when stocks reached a 6% gain by mid-February. It’s good news if this year continues that trajectory, because in 1996, the index ended up 20% on the year.

SPX Chart 3

— The Option Specialist

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