Chart of the day: medium-term returns

Yesterday, I presented a chart of the Dow’s (CPI) inflation-adjusted rolling 10-year return (the long-term), the point being that returns revert to the mean and then overshoot in long secular bull and bear waves. Today, I want to show you the same chart for 5-year returns (the medium-term).

My overall point?

Five-year returns almost never exceed 100% (denoted by the dotted red line in the chart). There are three notable bubble periods in stocks above 100%: pre-1929, pre-1987 and pre-1999*. This is not one of those periods.

Another factoid speaks against a precipitous drop. Interestingly, the 5-year return in September 2007 was 58.9%. By June 2008, it was 6.1%. That 52.8% drop is the largest 9-month drop in the Real 5-year Dow return since June 1988, exactly twenty years earlier. There has been no other drop of that magnitude in the Dow’s real 5-year return since 1938.

These data points should mean that, while stock market may decline, losses are likely to be somewhat contained. Whether the massive decline in return to June means the correction is behind us remains to be seen (I’m on record for believing the opposite). I found the data surprising and contrary to what my gut had been saying. Overall, the data are somewhat comforting for the market as a whole.

Financial stocks are another story.

*Note: the returns for the Dow during the Tech bubble topped out very early in June 1999 at 169.5%. This supports my thesis that the secular bear really began in 1998.

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