Thursday, December 10, 2015

Where Are Stock Prices Headed in 2016 and Beyond? ... History Teaches That in 2 of Every 3 Years, They Go Higher

The stock market has been getting roughed up the past several days as oil prices continue to head lower, and record low interest rates look like they will be increased slightly by the Fed over the next few weeks and months.

And although jobs are growing (albeit in a low inflation, slow growth and stagnant economic environment), America and the rest of the world are faced with terrorism, war, unrest, debt and profound long term economic problems. Yet our Jonathan Gruber type politicians don't act like they have a clue.

Meanwhile, our schools are underperforming and too expensive, Americans are aging and retiring earlier, the work force is getting smaller and uncompetitive globally, entitlements are becoming a bigger burden financially, and historic levels of debt point to a global economy that will be weak for many years to come. On the other hand, the dollar is strong and inflation is absolutely not a problem.

And it's going to be a sound bite filled election year. Gruberisms will abound, and many of We the People will take the bait --- probably too many.

So where are stock prices likely headed in 2016 and beyond? Probably higher, since that's what happens in two out of every three years on average, and assuming that history is a guide to the immediate future. And when predicting stock prices, history is a better predictor of prices than the so-called market pundits and experts. Play the odds, in other words.

Here are the odds that U.S stocks will rise in 2016 has much food for thought for individual investors:

If you’re like most investors, you’re encouraged by those odds. After all, the current bull market can’t last forever, and, depending on how you count it, it’s already one of the longest in U.S. stock market history.

In fact, the odds of the stock market rising next year would be the same even if we currently were in a bear market. That’s because the market’s odds of rising in a given year have nothing to do with how it does in prior years. Historically, those odds have been very close to two out of three.

Investors who find this result hard to fathom are guilty of what statisticians call the “gambler’s fallacy.” A common instance of this fallacy comes when we think that, after a coin comes up heads in six consecutive coin flips, there are better-than-even odds that the next flip will be tails. A coin, of course, doesn’t remember whether its previous flip came out heads or tails, so the odds are 50-50. The situation that applies to the stock market is remarkably similar.

Take a look at the chart at the top of this column, which summarizes . . . the Dow Jones Industrial Average back to its creation in the late 1890s. Notice that the odds of the market rising in a given calendar year are almost identical, regardless of whether the market in the previous year rose or fell.

For example, the Dow historically has exhibited a 66.7% probability of rising following years in which the Dow rose, versus a 65% probability following losing years. Those odds are statistically indistinguishable from the 66.1% odds of rising that apply to all calendar years since the Dow's creation nearly 120 years ago. . . .

Notice that this doesn’t mean the stock market can’t perform well in 2016. The point is that, if it does so, it will have nothing to do with how it’s done this year."

Summing Up

Stock prices increase two out of three years.

As a long term individual investor, I like those odds going into 2016 --- just like most other years.

That said, as we get further into the new year, we'll stay tuned and try to act as appropriate, including perhaps taking some money off the table.

That's my amateurish take.

Thanks. Bob.

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