CHAPELL HILL, NC — There’s a two-in-three chance of the stock market rising by the end of this year.
Before you get too excited by these odds, you should know that the same odds exist at the midpoint of every year. They remain the same regardless of how much the market has risen or fallen in the first half of the year, or the position of any of the myriad other indicators that investors usually look for when betting on intermediate stock market trends.
I’m taking the opportunity of the halfway point of 2022 to remind you to counter the broader trend of spotting patterns while none really exist. Some would argue that the second half is doomed to a similar fate when the first half of the year is bad. Opponents will insist on the contrary. Neither position is supported by the data.
This is because the stock market is looking forward. Its level at any time will reflect all publicly known information up to that point. So if the stock market falls during the first half of the year, as it certainly has in 2022, with the S&P 500 SPX down +2.45%, 23%, or when inflation is heating up, as happened over the past several months. , which will already be reflected in the stock prices. The same would be true for interest rate trends, market valuations, and where we stand in the presidential election year cycle.
This does not mean that these factors are irrelevant. This simply means that, to the extent they affect the DJIA of the market, the +2.15% probability of rising or falling, the market will have gone up or down before the year reaches the halfway point.
Imagine, for the sake of discussion, that a bad first half outweighs the likelihood of a bad second half. Had this been the case, traders would have reduced their equity allocation immediately instead of waiting till June 30 to do so. Their sale will lower the level of the stock market, increasing its chances of rising in the second half. This adjustment process will end when the profit prospects for the second half of the year are not as bad as they would have been otherwise.
A similar dynamic, but conversely, would come into play if a poor first half increased the odds of an above-average second half. In that case traders would immediately increase their equity investments, and their purchases would drive the stock market level until the second half of growth potential had subsided, otherwise not.
That’s the principle anyway. And it’s impressive how close the real world is to this theory, as you can see from this chart. It shows the probability of a market moving between July and December as a function of a dozen different variables. I chose dozens of these because each one specifically applies to this year.
Note how close each of the odds is to the overall average. No difference is significant at the 95% confidence level that statisticians often use when determining whether a pattern is real.
I said at the top of this column that you shouldn’t get too excited by the two out of three odds that the market will be higher at the end of the year, as they apply every year. But, in at least one sense, they’re good news: Because market levels already take into account all publicly known information, you can focus your analytical energy on forecasting companies’ future profitability. Huh.
It’s hard enough divulging the future without adding the added headache of constantly looking in the rearview mirror and revisiting the past.
Mark Hulbert is a regular contributor to MarketWatch. Their Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be contacted at [email protected],
