Around 10% is a familiar response to the question, “How much does the stock market go up in an average year?” But the real answer isn’t quite so simple.
For example, which stocks are we referring to? If we want a reflection of the global equity market, the MSCI All Country World Index (ACWI) is a reasonable place to start. The ACWI includes large- and mid-cap stocks across 23 developed-market countries and 24 emerging-market countries and covers approximately 85% of the world’s investable public companies. In the past 25 years (2001-25), its average gain is 8.9% per calendar year.
If we want to focus on U.S. equities, the S&P 500 has increased 10.3% on average in the same 25-year period. That aligns closely with the S&P’s longer-term average going back nearly 100 years (10.1% per year since 1928).
Those are the simple averages. The mean. Take each annual return, add them up and divide by total years. But you might be surprised to learn how rarely stocks actually deliver an average year. Going all the way back to 1950 gives us a larger sample size. In those 75 calendar years, the S&P gained between 7% and 13% only 10 times. In other words, an “average” year for stocks doesn’t happen very often at all.
Believe it or not, investors are more than three times as likely to experience a massively positive year. Since 1950, the S&P 500 has gained 20% or more 26 times. That’s a hit rate of 35%. If we exclude years in which the U.S. economy was in recession, the numbers are even better (42%).
This is the time of year, of course, when market predictions are everywhere. If you read enough of them and crunch the numbers, you will notice the most common predictions suggest the next 12 months will see stocks increase between 7% and 13%. From now on, you can chuckle a little harder knowing just how unusual those are.
What is more useful is understanding how current valuations affect projected equity returns. As of late January, the forward price-to-earnings (P/E) ratio of S&P 500 companies is 22.1. That’s significantly higher than the 10-year average (18.8).
Valuations are notoriously poor indicators of short-term stock performance (the next 12 months), but they are meaningful factors in predicting returns in the next decade. Historical analyses concluded starting valuations are the basis of 80% of the variability in the S&P’s 10-year returns. Higher valuations (expensive stocks) lead to below-average returns in the next decade. Cheaper valuations lead to above-average returns.
