Understanding stock market returns in 2019

I think it’s fair to say that stock market returns in 2019 surprised a lot of people.

The S&P500 returned approx. 30%. The MSCI World Index returned > 27%.

To put this into context, over the last 90 years the average annual return for the S&P500 is just shy of 10%. In 2019, the S&P500 return was almost 3x the average. What makes this remarkable is that the general consensus going into 2019 was not exactly rosy. The sell-off in December 2018 was the worst December since the Great Depression in 1931.

Economic Regimes in 2019

To understand 2019 returns, we have to look a little further back to mid 2018. Regime 2(1)Expanding Growth, Rising Inflation was active until November 2018 when the warning bells started ringing. Declining Growth saw a shift into Regime 4,(2)Declining Growth, Rising Inflation signalling an imminent market correction which eventuated in December. The chart below overlays S&P500 with the economic regimes.


In mid December 18, another regime shift occurred. This time to Regime 3.(3)Declining Growth, Declining Inflation Importantly, this shift into Regime 3 can be classed as a recovery. Conditions were actually improving following the Regime 4 conditions in November 2018.

Let’s look at some historical instances of Regime 3 recoveries. The chart below looks at instances of R3 (Recovery) against the S&P500.


What is immediately apparent is that the duration of the Regime 3 recovery in 2019 is the longest since 2001, which is the earliest data from the regime model. The second longest Regime 3 recovery phase started in late October 2008, during the financial crisis.

Regime 3 recoveries have preceded bull markets historically. The economy gains steam and moves on to Regime 2 and 1 as growth improves and inflation is on a positive trajectory yet not excessive.

I’m not saying this means we’re on the verge of a bull market. In fact, I think caution is required. Let’s look at historical market returns for the SPY and GLD ETFs during Regime 3 recoveries.

 SPY Regime 3 RecoveryGLD Regime 3 Recovery
# Years:1414
Starting Equity: $100,000.00 $100,000.00
Ending Equity: $114,126.53$175,174.34
Total Return:$14,126.53$75,174.34
Total Return (%):14.13%75.17%
Compound Annual Growth Rate:0.95%4.09%
Profit Factor:1.262.85
Return/Drawdown Ratio:0.5110.65
Avg Annual Return (%):1.91%8.42%
Avg Monthly Return (%):0.44%1.79%
Standard Deviation (%):4.28%3.71%
Worst-case Drawdown (%):-27.58%-7.06%

I know which market I’d rather be invested in. Gold is clearly superior both outright and on a risk adjusted basis during regime 3 recovery phases, suggesting there is a lot of uncertainty here.

What does this mean for 2020?

I’m not into forecasting so I’m not going to make any grand predictions here. I generally have a view, but if information contradicts my perception I change my mind without any hesitation. Now that I’ve qualified that, I am concerned about the length of the regime 3 recovery through 2019 and into this year. Growth is improving but my primary concern is inflation. If it continues to rise and outpace growth we’ll be back into regime 4 and another potential market correction.(4)I reserve the right to be totally wrong. Listen to the data, not me

Keep track of the US Growth and Inflation Surprise Indices here.


1 Expanding Growth, Rising Inflation
2 Declining Growth, Rising Inflation
3 Declining Growth, Declining Inflation
4 I reserve the right to be totally wrong. Listen to the data, not me