With the S&P 500 Index in correction territory (down more than 10% from the previous peak) while the market faces a number of big threats, including inflation, a hawkish Federal Reserve, soaring yields, and war in Eastern Europe, investor anxiety levels are understandably elevated. During volatile markets, it’s difficult to focus on anything beyond the short term, but at times like this studying market history for reminders of the benefits of long-term investing can be helpful for investors.
“Individual investors have the benefit of time on their side,” wrote LPL Financial Equity Strategist Jeffrey Buchbinder. “History shows that patience is rewarded during volatile periods in the market. This looks like one of those times.”
Below are 6 charts we think may help investors stay focused on the long term.
First, simply put, stocks have gone up over time as shown in the chart below. Based on this 122-year data series of the Dow Jones Industrials, stocks have gained 9.5% annualized including dividends. That’s a pretty good long-term track record.
So what has driven those big gains for stocks all those years? Earnings, plain and simple. While we don’t have 122 years of earnings data for the Dow, we do have 70 years of S&P 500 earnings per share data, shown in the chart below. Earnings have grown at an annualized pace of 7.5% over this time period, consistent with long-term stock price appreciation (excluding dividends).
The next chart shows how punitive it can be to be out of the market on its best days. Though the S&P 500 Index is unmanaged and can’t be owned directly, it’s clear that owning stocks for the long run has been very rewarding and moving in and out and potentially missing out on gains can be costly. Stocks experienced some significant downdrafts during the 31-year period shown in the chart (2000-2002 and 2008-2009 to be specific) and yet the S&P 500 Index still rose an average of 9.9% per year during that time.
The next chart shows the probability of S&P 500 Index gains over various rolling time periods since 1950. Based on monthly data, the index was higher in more than 80% of all rolling 3-year and 5-year periods. Going out further, 92% of all 10-year rolling periods saw the S&P 500 move higher, while the S&P 500 was higher 100% of the time for all rolling 15-year periods. In other words, those with a greater than a 10-year investing time horizon have an excellent chance to achieve positive returns.
It’s also important for investors to remember that when stocks fall, they usually become cheaper relative to earnings. LPL Research certainly believes this is relevant today given the solid earnings trends still in place (despite several high profile disappointments among mega-cap tech and internet stocks this quarter).
The next chart illustrates the relationship between stock valuations—measured by the S&P 500 price-to-earnings ratio (P/E)—and future stock performance. Specifically, the chart shows the future 10-year returns an investor might expect based on the valuation levels at a given point in time. If this relationship holds going forward, then buying stocks at a 19 P/E today positions investors for better long-term returns—perhaps 5-6% annually—than the 24 P/E observed at the start of the year. Note that the P/E scale on the chart’s right axis is inverted, so a rising line reflects lower valuations.
Earlier this week LPL Financial Chief Market Strategist Ryan Detrick published a chart (shown here) showing the average maximum peak-to-trough decline in a given year has been 14%. Put another way, as shown in the chart below, on average the S&P 500 has experienced one 10% or greater correction per year. The takeaway here is that the volatility experienced this year, with the S&P 500 falling 13% from January 3 through March 8, is actually quite normal.
So there you have it. Six charts to help put the latest bout of volatility in perspective and remind us of the benefits of long-term investing. Bottom line, be patient, stick to your plan, and if you have a long-term time horizon with a relatively conservative asset allocation, this might not be a bad time to consider adding some equities.
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