How Does The Stock Market Perform After a Down Year?

It was an awful year for the stock market in 2022.

Inflationary pressures and rising interest rates coincided with the beginning of a brutal war in Ukraine, bringing about a seemingly unprecedented set of headwinds that wreaked havoc for investors across the globe.
 
Indeed, the S&P 500 closed out the year 18% down, with the tech-heavy Nasdaq-100 Index faring even worse, dropping 33% by the end of December.
 
However, there is some hope on the horizon. Historically, the markets have often bounced back strongly following an annual decline. For example, in 2009, the S&P 500 rebounded 26% following a 37% drop, while, in 2003, the index recovered 28% after a 22% fall the year before.
 
So, will shareholders be rewarded with a profitable year in 2023? Or are there further losses on the way?
 
Source: Unsplash

History Is On Our Side

When it comes to the raw statistics, everything suggests that the next twelve months should be good for investors.

In fact, it’s actually been extremely rare to see back-to-back losses for the S&P 500 anytime during the last 95 years.

For instance, since 1928, there have only been four occasions where the market has fallen for more than two years on the trot.

This happened first during the Great Depression of 1929, when the S&P 500 delivered four straight periods of annual losses up to 1932. The onset of the Second World War triggered another three-year decline, with two more in 1973 and 1974 during the oil crisis of that decade.

Indeed, it wouldn’t be until 2000 and the dot-com bubble that the market would witness consecutive down years again.

It’s a similar story with Nasdaq too, which has only registered subsequent yearly declines once since 1986.

Even more reassuring is the fact that when the market does bounce back, it tends to do so with a vengeance. The Nasdaq, for example, rose by an average of 51% after recording a loss the year before, with the S&P 500 soaring almost 53% in 1954 after it had fallen in 1953.

It’s Not All Good News Though

While investors should be buoyed by the positive historical trends that imply a recovery could be on the cards, there are definitely reasons why you should proceed with caution.

Indeed, when the S&P 500 does fall for more than one year in a row, the second year is always more painful than the first. For instance, after dropping 14% in 1973, the index tanked another 25% throughout 1974.

Whether the stock market performs as many would hope in 2023 remains to be seen, but there are certainly many factors that could mitigate against it.

To begin with, an end to the war in Ukraine does not appear to be in sight. This will continue to put pressure on energy and commodity prices, leading to further geopolitical instability in the region and abroad.

Moreover, although the coronavirus pandemic seems to be receding in the west, that isn’t the case in China. In fact, it is rampant in many parts of the country, which will no doubt have a knock-on effect for supply chains around the world. For example, Asia is a major player in the semiconductor space, and any disruption to the labor force that keeps the industry running will impact many other sectors reliant on its microchip technology.

On top of that, macroeconomic issues closer to home have yet to fully resolve themselves either. Many analysts believe that “U.S. equities may disappoint in 2023,” as revenue and earnings expectations are set unrealistically high.

Which Sectors Perform The Best When The Market Recovers?

After waking up from a down year like the one the market experienced in 2022, it’s usually the more growth-oriented sectors that tend to outperform. This is partly due to a return of investor confidence and a willingness to take on extra risk to achieve those higher returns.

As such, technology stocks are often some of the most exciting growth prospects to be found anywhere on the market, offering investors the opportunity to tap into cutting-edge industries that are constantly evolving.

But what makes technology stocks so special?

Well, it’s one of the most exciting and rapidly expanding sectors, packed with both dynamic and forward-thinking businesses constantly introducing new products and services to their customers. This combination of high potential and a willingness to experiment makes it especially attractive to growth-oriented investors.

However, when the market does begin to emerge from a difficult period, a focus on de-risking your portfolio with defensive stocks might also be a prudent course of action.

Indeed, there are several reasons why defensive stocks do so well when the market has been beaten down. For one thing, as these companies sell products or services that are considered a necessity, they tend to be less affected by economic downturns as their wares are never out of fashion.

Furthermore, defensive stocks often have strong balance sheets and pay healthy dividends. This can provide a measure of stability and income for investors when other parts of the market are in turmoil. And finally, these enterprises are usually less volatile than the overall market, providing some downside protection during arduous times.

Conclusion

While history is said not to repeat itself, it definitely rhymes.
 
And going by how the stock market has performed over the last century, there are very good reasons to believe that 2023 will be a resurgent year.
 
However, successive annual declines are not exactly the Black Swan that some might wish to believe – and nothing in the financial ecosystem is ever certain.
 
It therefore makes sense for investors to plan for the worst, but hope for the best. Position your portfolio to benefit from upside gains if the market rises higher – but diversify enough to be resilient to fight another day.

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