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What New Market Highs Mean for Long-Term InvestorsSubmitted by Flourish Wealth Management on April 28th, 2017
After a brief pause earlier this year, many markets worldwide have recovered to all-time highs, with some indexes even setting new records. While this is a good thing for investors, it nonetheless raises good questions about how long this positive market trend can continue. In fact, we are starting to get questions from clients if now is the time to take advantage of these levels and get out of the market.
At Flourish Wealth Management, we work with clients to build a diversified portfolio that is designed to achieve their unique goals and objectives. Our investment process reflects a diligent approach to understanding long-term market characteristics, resulting in a portfolio that may need occasional tweaks to stay on track but is designed to remain fully invested across market highs or lows. A look back at history tells us that new market highs are actually a rather poor indicator of future market movements. The graphic below illustrates that after a new monthly high in the S&P 500 Index, the market goes higher still in the following 12 months in roughly the same consistency as all other periods. In other words, the market tends to perform roughly the same in the year following a new high as it does without a new high.
Investors might feel additional concern over new high levels in markets at this point, especially as the financial crisis of 2008 still looms large in our memory and the ensuing recovery has been slower and longer than normal. However, while the current level of market highs might seem lofty, another lesson from history is that the US market makes new monthly highs approximately 29% of the time2. Stated differently, it is common for the market to make new highs in three to four months each year. Of course, this doesn’t mean this will happen every year since there are crises and recessions that cause market slumps, but the takeaway here is that new highs are actually a relatively normal event and not something that indicates investors should be concerned.
Since market highs alone aren’t useful to help investors determine if they need to adjust their portfolio, we examined if there are additional factors that might help drive decisions. We believe two other factors – economic fundamentals and investor sentiment – are useful in framing the picture.
A look at economic factors may help determine if new market highs are supported by fundamentals or if there is a mismatch between market and economic performance. While a detailed discussion of current factors is outside the purview of this article, we believe generally the US economy remains on solid footing, at low risk of recession and supported by a strong employment environment and other factors. 3
While we tend to focus strongly on the fundamentals, a more “technical” indicator is investment sentiment. As the graphic below illustrates, there tends to be a feeling of euphoria in markets at the peak of the business cycle bubble, only to succumb to fear as the cycle turns down. As Warren Buffet is often credited with saying, “be fearful when others are greedy”.
We do not sense that sentiment has gotten out of control or euphoric even at current market highs. In fact, there seems to be plenty of gloom to go around whether it’s over the geopolitical tensions with North Korea, politics closer to home, concern over the potential course of monetary policy worldwide, or other risks. While these risks don’t help investors’ moods, they do tend to keep markets somewhat grounded in fundamentals and from escaping to euphoric levels. Markets may actually perform well when risks like the ones mentioned above are apparent, leading to another adage that “markets climb a wall of worry”. In other words, worries over geopolitics or other risks do not necessarily mean markets cannot continue at their historical pace of making (relatively frequent) new highs.
We certainly do not predict markets will continue to trudge ever higher. In contrast, even healthy bull markets experience “corrections” or moderate drops along the way. Instead, we continue to believe that investors should stick to their well-diversified, long-term financial plan. This means trimming back on stocks if necessary to maintain an appropriate asset allocation, but it does not mean trying to time markets and get out of the stock market just because it is making new highs. When considering other factors such as economic fundamentals and investor sentiment, new highs may well just be part of a healthy market.
1 From January 1926-December 2016 (1,081 monthly observations). Data from Dimensional Fund Advisors and Standard & Poor’s Index Services Group. For illustrative purposes only. Index is not available for direct investment. Past performance is no guarantee of future results.
2 From January 1926-December 2016; 319 months out of 1,081 months represented new closing highs in S&P 500.
3 Federal Reserve Bank of St. Louis, Smoothed US Recession Probabilities January value of 1.36 indicates low chance of near term US recession. US Jobless claims 4-week moving average as released on 4/20/17 at 243,000, near the low for the current recovery/expansion. US BLS Nonfarm Payrolls “Employment Situation” report indicates Unemployment rate at 4.5%.