OVER THE LAST FIVE YEARS, THE STOCK MARKET HAS ONLY DECLINED ABOUT 23% OF THE TIME: WHAT GOES UP RARELY GOES DOWN

The stock market has been remarkable the last five years not only because of how much it has gone up, but also because of how infrequently it has declined.

The accompanying chart shows the percentage of months which the stock market declined over trailing five-year periods since 1870. Over the entire 128 years, the stock market has declined about 43% of the time.

Investing in stocks is not quite a coin flip, but it’s close. Throughout most of U.S. history, the probability that stock prices would fall has remained in a tight range, mostly between about 35% and 55%.

There have been only a handful of episodes where the odds in the stock market have varied significantly from this range. During the last five years of the great 1920s bull market, stock prices fell only about 17% of the time. By contrast, during the end of the bear market of the 1970s, the stock market declined about two-thirds of the time.

Falling stock prices are rare again in the current bull market. During the last five years, the stock market has only declined about 23% of the time — the second-lowest frequency of downside risk on record. Like the 1920s bull, the contemporary bull has been a virtual “no-risk” stock market.

Why was downside risk so low in the 1920s and again in this decade? The common link between the 1920s and the contemporary bull market are interest rates. Only three decades since 1870 have produced a significant decline in yields without a significant economic decline — the 1920s, 1980s and 1990s.

As the chart shows, during each of these decades, the frequency of falling stock prices declined substantially. During the 1920s, it fell to a record low. In the 1980s it dropped from about 65% to 37%. And so far in the 1990s, it has fallen to less than 25%.

Whenever the economy has simultaneously grown and produced a trend of lower yields, the downside risk in stock prices has been low. Will our current “no-risk” stock market continue into the next millennium? We think it might.

Of course there will be times when stock prices correct. However, should inflation remain low or possibly even move lower in the next several years, then long-term yields will likely follow suit. If the U.S. economic engine continues to grow while yields fall, the frequency of stock market declines may keep moving lower.

For contrarians, this chart is scary — we seem overdue for more normal cyclical bear markets.

For us optimists, however, perhaps this chart will eclipse the 1920s’ no-risk bull record in the next few years.

James W. Paulsen is chief investment officer of Wells Capital Management. He is based in Minneapolis.