There has been a lot of speculation in recent months that 2002 will be a good year for the stock market. Why? Because 2001 and 2000 were both losing years, and the market rarely has three losing years in a row, many pundits have argued.
This argument is probably wrong on several counts. For one, the stock market’s current results probably aren’t related to yesterday’s results. Many studies of day-to-day and week-to-week variations in stock market prices have shown that there is no statistical link between today’s performance and tomorrow’s. If the market goes up today, there are just about the same odds that it will go up tomorrow as it will go down.
Proponents of a good 2002 argue that the previous two-year bear market augurs well. They say that after most two-year declines the market has increased in the third year. That’s true, but not always true. During the Great Depression the market fell sharply in 1929 and 1930, but it didn’t go up in 1931. Instead, it fell by 43%. It didn’t go up in 1932, the fourth year, either – it fell by another 8.6%.
Going back to 1872, there have been eight declines in two back-to-back years. The market increased in the third year after six of those declines, or about 75% of the time. Bulls who say that means 2002 will be a good year argue that 75% odds are worth betting on. That may be true, but it has nothing to do with the two-year decline we have experienced. In any year since 1872 the market has had about a 75% chance of rising. In other words, the market rises three out of every four years, on average.
That still puts good odds on 2002 being a winning year, but it doesn’t mean that it will necessarily be so because we have just gone through a two-year decline. There is still a 25% chance that a two-year decline could stretch out for a third year.
In the end, none of this should matter to a long-term investor. Ten or 20 years from now what happens to the market this year will have little significance. Someone who already has a diversified portfolio should hang on and keep it in balance through 2002. Someone who is investing new money can buy into investments throughout the year and look forward to future up years.
