In 1926, the Composite Stock Index was created to measure market trends. Initially, it tracked the performance of 90 companies, but it was updated to include 500 companies in 1957, and thus the S&P 500 (^GSPC -0.88%) was born. While its constituents have changed over the years, the S&P 500 still includes a blend of large-cap value stocks and growth stocks that span all 11 market sectors. For that reason, the diversified index is often viewed as a benchmark for the entire U.S. stock market.
Last year, economic uncertainty surrounding red-hot inflation and rapidly rising interest rates caused the S&P 500 to fall 19.4%, marking its fourth-worst performance in history.
Here's what investors should know.
Image source: Getty Images.
History says the stock market could rebound in 2023
Since 1957, the S&P 500 has only fallen more sharply than 19.4% in three years: 1974, 2002, and 2008. Each of those downturns was precipitated by major economic headwinds.
In 1974, gasoline shortages and double-digit inflation rates caused the S&P 500 to plunge 29.7%. In 2002, the fallout from frenzied investments in internet technology companies and the subsequent implosion of the dot-com bubble caused the S&P 500 to drop 23.4%. And in 2008, the collapse of the U.S. housing market and the subsequent global financial crisis caused the S&P 500 to fall 38.5%.
What happened next? In all three cases, the broad-based index staged a spectacular recovery in the year immediately following its meltdown. In fact, the S&P 500 produced an average return of 27.1% in 1975, 2003, and 2009. The details are provided in the chart 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 buried in the data. Since its inception in 1957, there have only been two occasions in which the S&P 500 fell for two (or more) consecutive years. The index posted back-to-back declines in 1973 and 1974, and it fell for three consecutive years between 2000 and 2002.
The former is particularly noteworthy because inflation started trending upward in early 1973, and it peaked at 12.2% in November 1974. The S&P 500 then mounted a recovery in 1975. Something similar has played out over the past two years. Inflation began rising in early 2021, and it peaked at 9.1% in June 2022. That trend, assuming it continues, could trigger a bull market rally in 2023.
As a caveat, that is little more than speculation. The similarities between 1974 and 2022 only go so far, and every stock market downturn 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 rebounded from every past downturn, and there is no reason to believe this one will be any different.
The smartest thing investors can do right now
The best way to capitalize on the stock market downturn is to invest on a regular basis. In the last two decades, more than 80% of the S&P 500 index's best days occurred during a bear market or the first two months of a bull market (i.e., before it was clear the previous bear market had ended) and missing even a few of those days can be a very costly mistake.
Of course, not all beaten-down stocks will regain their previous highs. But there are plenty of good businesses in growing industries -- like Shopify in e-commerce, Amazon in cloud computing, and Tesla in electric cars -- and many are trading at heavily discounted 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 discusses, Warren Buffett owns two S&P 500 index funds through Berkshire Hathaway, and he has often said an S&P 500 index fund is the best option for most investors.
