Stocks are at Record Highs, Should We be Worried? [Video]

Stocks are at record highs, should we be worried?

Currently, the headlines are bit nerve-wracking from the Delta variant and the economy, to the Fed and stock market highs.  It is natural to wonder what is around the next corner.

Historically, stocks are at all-time highs 30% of the time

The mere fact that stocks are at record highs now should not be a primary concern for investors. The challenge is that from an evolutionary psychological perspective, we have developed an innate fear of heights that has helped preserve our species over the millennia. It is only natural to be cautious when we find ourselves at new heights, whether that is on an Eastern Sierra mountain top or in front of a computer looking at investment charts. Unfortunately, instincts that help humans survive in the natural world often work against investors.  It is helpful to look at the data to gain further perspective:

The second column illustrates that the S&P 500 was higher 1, 3 and 5 years after closing at a new monthly high more that 77% of the time. The annualized returns over these periods ranged from 9.9% to 13.9%.  These figures are similar to the ones found in column three that illustrate the percentages and returns of the S&P 500 after closing at any previous level.  The data simply doesn’t support the notion that market highs are any more precarious than any other market level.  In fact, the S&P 500 is historically at all-time highs 30% of the time. 

The last time I shared this data was in a presentation at the end of January 2018 as the S&P 500 set a then record high.  At the time, attendees were generally skittish about the level of the stock market.  Now, three and a half years later, the S&P 500 is up about 67% (as of July 29th) after returning more than 15% per year.  These returns came with bumps and  bruises, including at 10% drop in February 2018, a brief 20% decline in December 2018 and the COVID-19 cliff in 2020.  In fact, volatility in the equity markets is to be expected.  Dating back to 1942,  5% declines have occurred about 3 times per year, with 10% corrections annually, and 15-20% declines every 3-5 years. 

Market timing in ineffective

There is a natural impulse to want to sell stocks when markets are at highs. However, acting on such an inclination can seriously hamper long-term investment returns.  The last 20 years have provided an annualized 7.5% return in the S&P 500 through December 2020.  This time period included a 49% decline as the Tech Bubble (2000-2002) unwound, a 57% downturn due to the Financial Crisis (2008-2009) and a 34% plunge with the COVID pandemic over a total of 5,537 trading days.  If just 10 of the best trading days over these two decades were missed, the return of the S&P 500 would have been reduced by more than half.  Missing the 20 best days distilled the return to nearly zero.  Missing the best 30 days or more resulted in negative returns.  Here's a closer look at the data:

Risk management tools are the key to sleeping well at night

With market timing ineffective in the long run, our primary risk management tools are asset allocation, diversification, rebalancing, tax loss harvesting, investment strategy, and strategic financial planning.  We have employed all of these tools over the years in both favorable and unfavorable market conditions.  While we don’t know exactly what lies ahead, we remain cautiously optimistic and at the ready.

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