The brain is a pattern-seeking mechanism and nowhere is this more on display than when attempting to time financial markets – especially when new market highs are reached.
At the new high, the anxious investor wonders if a market correction is due. We call the syndrome “waiting for the other shoe to drop,” a way to describe apprehension intruding upon hopeful experiences. So, to the pattern-seeking mind of the anxious investor, it seems as though new highs are inevitably paired with downturns that are in equal measure to prior gains.
Based on 92 years of stock market history, we observe a different pattern. Record highs are often (not always) followed by hefty returns in the subsequent one-, three-, and five-year periods (see “look ahead periods” in the exhibit below). That pattern makes no guarantees yet argues against going to the sidelines whenever the market hits new highs.
Average Annualized Returns After New Market Highs S&P 500, January 1926–December 2018
In US dollars. Past performance is no guarantee of future results. New market highs are defined as months ending with the market above all previous levels for the sample period. Annualized compound returns are computed for the relevant time periods subsequent to new market highs and averaged across all new market high observations. There were 1,115 observation months in the sample. January 1990–December 2018: S&P 500 Total Returns Index. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. January 1926–December 1989; S&P 500 Total Return Index, Stocks, Bonds, Bills and Inflation Yearbook™, Ibbotson Associates, Chicago. For illustrative purposes only. The index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the management of an actual portfolio. There is always a risk that an investor may lose money.
Indeed, the decade-long economic expansion has slowed significantly. Contributing to the slowdown are trade tensions as well as the unresolved Brexit conundrum. In turn, while awaiting a more predictable environment, corporate boards have curtailed expansion of payroll and production. This is already reflected in stock prices.
There may be some uptick in volatility, but as to when there will be corrections we will never know. At the same time, to mitigate - but never eliminating risk - we use asset allocation, the diversification among various classes of stocks, bonds, etc. Even when (not if) they arrive, economic slowdowns and market downturns are cyclical; they’re temporary and not the end of the overarching prosperity that inevitably flows from free enterprise.
Over time, capital markets have rewarded investors who take a long-term perspective and remain disciplined in the face of short-term noise. By focusing on what they can control, our clients are in a better position to make the most of what capital markets have to offer. We employ appropriate asset allocation, diversification, and manage expenses, portfolio turnover, and taxes.
In general, we find ourselves in an economic cycle without double-digit returns for the past year. Yes, the economy and markets seem to have stalled. Some segments of the market, small-cap, and large foreign stocks, for instance, have registered negative returns for the past year. When they’ll recover or when we will see a double-digit return, we cannot say. But investors “must be present to win.”
We are pleased to enclose the Third Quarterly Performance Review, which details the performance of your personal portfolio, net of advisory fees that are detailed on a separate sheet. As always, we welcome your call to discuss in further detail and to consider any changes in your situation. Thank you for this opportunity to be of service.
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