CHAPEL HILL, N.C. (MarketWatch) — There’s a two-out-of-three chance that, on Dec. 31, the stock market will be higher than it is today.
That certainly appears to be good news, since the Dow Jones Industrials Average DJIA, +0.03% is already sitting on a year-to-date gain of more than 15% (assuming dividends were reinvested). Additional gains would assure 2019’s place in the record books as one of the better ones in U.S. history.
Unfortunately, this news isn’t as good as it appears. The odds of a rising market between July and December would be the same even if equities today had produced a year-to-date loss.
That’s what I found upon feeding into my computer’s statistical package the historical data for the Dow Industrials back to its creation in the late 1800s. Over the 120-plus years since then, the Dow has risen 66.4% of the time from July through December. In years in which the Dow rose in the first half of the year, the odds of a positive second half were 72%.
That difference between 66.4% and 72% is not significant at the 95% confidence level that statisticians often use when judging whether a pattern is genuine. In other words, our best guess from a statistical point of view is that the stock market’s second-half odds are independent of its performance in the first half.
Nor do the odds of a strong second half go up when the Dow performs particularly well in the first half, as it has this year. This is well-illustrated in the accompanying chart — a scatter plot in which each dot represents the Dow’s second-half performance as a function of its first. Be my guest trying to find a pattern in the data.
Take 2007. The Dow over the first half of that year produced a 7.6% return, which is well above the historical average. Yet the financial crisis-induced bear market began later that year; for the entire second half of that year, the Dow shed 1.1%.
An even more spectacular example came in 1987. The Dow in the first half of that year gained an incredible 27.6%, but in the second half lost 19.8%.
Market efficiency is the core reason why the stock market’s second-half odds are independent of its first-half performance. The market-clearing price at any given time is set at whatever level represents an approximately two-out-of-three chance of the market rising over the coming six months. If a price is so high as to markedly reduce those odds, then the market falls — just as it will rise if a price is too low.
Notice carefully that this price-setting proceeds without regard for how the market has performed over the six months prior. The market is forward-looking, a discounting mechanism.
So by all means celebrate the stock market’s stunning performance so far this year. But, tomorrow, or July 1, or any day for that matter, represents a brand-new, fresh start for the market. Plan accordingly.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected].