Probability of the markets

This week in Spain thousands of people got together to celebrate the official start of the San Fermin festival. This festival includes the famous running of the bulls. The question here at home is will this famous event be symbolic of things to come in the markets. Will the bulls run back on Wall Street or will the Bears continue to hold their ground?

The questions I get wherever I go now are: What’s going to happen to the markets? Are they going to turn around? Have we hit the bottom yet?

Wouldn’t you like to know? Actually, so would I! All of these questions are on the minds of all investors. Really, there is nowhere to hide these days? Markets all around the world are feeling the pinch. In fact, only 5 of 24 of the major world markets are in positive territory this year.

Any answers to these questions are speculative in nature because no one really knows. Market timing is impossible to do with a 100% degree of accuracy.

However, one might be able to view some of these questions using probabilities. After all, investing is an inexact science. The trick is to be right more often than wrong and win more often than you lose.

It all depends on the time

Over what time frame do you formulate your expectations? If you were to ask me will markets start to turn around in the next 6 months to a year, the prudent answer would be to give a 50/50 probability because markets are random in the short term. Consider some statistics to help you to come to your own conclusions:

  • Since 1957 on the TSE 300, there have only been 3 calendar years where we had 3 consecutive back to back negative years (73/74, 69/70, 52/53).
  • On a rolling basis, the TSE 300 has experienced negative returns over 1 year periods 25.2% of the time and positive returns 74.8% of the time.
  • The TSE 300 has experienced 1-year drops in excess of 15% only 5.6% of the time.
  • When markets have dropped in excess of 15%, they have rebounded on average 31.3% with returns ranging from a low of 7.4% to a high of 86.9% over the following year.

While historical evidence is no guarantee for future performance, the data suggests that there is likely a higher probability of future upside rather than continued downside even with a relatively short time frame.

The longer the time frame, the higher the probability that markets will rebound.

If we look at rolling 3 and 5 year periods, markets tend to provide a higher likelihood for positive returns. This is the reason many financial experts will tout the merits of long term investing and staying invested through tougher times like today’s market environment.

On a rolling 3 year basis on the TSE in the last 15 years,

  • The average 3-year return over any 3 year period is 10.66%
  • The worst 3 year period was -3.44% from September 1987 to September 1990
  • The best 3 year period was 23.85% from April 1995 to April 1998
  • On a rolling basis, the TSE 300 has experienced negative returns over 3 year periods only 3.5% of the time.

On a 5 year basis, the picture improves even further in terms of downside risk. There were no negative returns over any 5 year period since 1986.

So, if the question was re-phased to ask “In the next 3 to 5 years, will the market rebound to produce positive returns?”, the likelihood is great that we will see a recovery in the next 3 years.

As a fan of numbers, statistics and probabilities, the historical experience can help us to understand how markets move. These observations do not guarantee that markets will rebound but they do highlight the likelihood of some recovery occurring in the near future. The only thing we know for sure is to make money in investing, we must ‘Buy Low, Sell High’. For me, it’s time to buy given a little patience.

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