There’s a two-out-of-three chance the US stock market will rise in 2022. A 66% probability of a rising market next year seems downright attractive, given that equities have more than doubled over the past 18 months. What many investors don’t realize is that these market odds stay the same from year to year, regardless of what’s come before.
Investors have a hard time accepting this because they believe the market exhibits trends. They assume that a good year makes it more likely the subsequent year will be rewarding, and a poor year sets up the probability of another disappointing year. Contrarian investors make a conceptually similar mistake. They think the market regresses to the mean, which would mean that an above-average year would be more likely followed by a below-average year, and vice-versa.
Both investors and contrarians are wrong, because the stock market discounts the future, not the past. As market theoreticians teach us, an efficient market’s level at any given time should reflect all information that is publicly-available. Market will rise or fall according to changes in anticipated future returns.