In 1926, the Composite Stock Index was created to measure market trends. It originally tracked the performance of 90 companies, but was updated in 1957 to include 500 companies, and thus the S&P 500 (^GSPC 0.40%) was born. Though its constituents have changed over the years, the S&P 500 still contains a mix of large-cap value and growth stocks, covering all 11 market sectors. Because of this, the diversified index is often viewed as a benchmark for the entire US stock market.
Over the past year, economic uncertainty coupled with sweltering inflation and soaring interest rates caused the S&P 500 to fall 19.4%, making it the fourth-worst performer in history.
Here’s what investors should know.
Image source: Getty Images.
History says the stock market could recover in 2023
Since 1957, the S&P 500 has fallen more than 19.4% in three years: 1974, 2002, and 2008. Each of these downturns has been triggered by major economic headwinds.
In 1974, gas shortages and double-digit inflation sent the S&P 500 down 29.7%. In 2002, the aftermath of frantic investment in Internet technology companies and the subsequent implosion of the dot-com bubble sent the S&P 500 down 23.4%. And in 2008, the collapse of the US housing market and the ensuing global financial crisis caused the S&P 500 to fall 38.5%.
What happened after that? In all three cases, the broad index rallied spectacularly in the year immediately following its collapse. In fact, the S&P 500 averaged returns of 27.1% in 1975, 2003, and 2009. The details are shown in the graphic below.
Year | S&P 500 return |
|---|---|
1974 | (29.7%) |
1975 | 31.5% |
2002 | (23.4%) |
2003 | 26.4% |
2008 | (38.5%) |
2009 | 23.5% |
Data source: Yardeni.
There is another interesting fact hidden in the data. Since its inception in 1957, there have only been two occasions when the S&P 500 has fallen for two (or more) consecutive years. The index recorded consecutive declines in 1973 and 1974, and fell three years in a row between 2000 and 2002.
The former is particularly notable as inflation began to rise in early 1973 and peaked in November 1974 at 12.2%. The S&P 500 then rallied in 1975. Something similar has happened over the past two years. Inflation started to rise in early 2021 and peaked at 9.1% in June 2022. If this trend continues, it could trigger a bullish rally in 2023.
As a caveat, that’s little more than speculation. The similarities between 1974 and 2022 only go so far, and every stock market decline in the past was caused by its own unique confluence of world events. More importantly, past performance is never a guarantee of future returns, and not even the best analysts on Wall Street can predict the future.
However, the S&P 500 has undeniably recovered from every previous downturn, and there’s no reason to think this one will be any different.
Smartest thing investors can do right now
The best way to capitalize on stock market downturns is to invest regularly. Over the past two decades, more than 80% of the S&P 500 Index’s best days have occurred during a bear market or the first two months of a bull market (i.e., before it was clear that the previous bear market had ended) and even lacked a few of those days be a very costly mistake.
Of course, not all depressed stocks will revisit their previous highs. But there are many good companies in growing industries – such as Shopify in e-commerce, Amazon in cloud computing and Tesla in electric cars – and many are traded at greatly reduced prices.
Alternatively, an S&P 500 index fund is a great option for investors looking to do a little less work. In fact, as my colleague Katie Brockman explains, Warren Buffett owns two S&P 500 index funds Berkshire Hathawayand he has often said that an S&P 500 index fund is the best option for most investors.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Trevor Jennewine has positions at Amazon.com, Shopify, and Tesla. The Motley Fool has positions in and recommends Amazon.com, Berkshire Hathaway, Shopify, and Tesla. The Motley Fool recommends the following options: long January 2023 $1,140 calls on Shopify, long January 2023 $200 calls on Berkshire Hathaway, short January 2023 $1,160 calls on Shopify, short January 2023 $200 puts on Berkshire Hathaway, and short January 2023 $265 calls on Berkshire Hathaway . The Motley Fool has a disclosure policy.