Treat record high stock prices with neither excitement nor alarm.
KEY TAKEAWAYS
- Financial journalists stoke investor “record-high” anxiety by implying in articles that physical laws apply to financial markets—what goes up must come down.
- But shares are not heavy objects kept aloft through strenuous effort. They are intangible perpetual claims on firms’ future earnings and dividends.
- If stocks have a positive expected return, continually reaching record highs even for extended periods are outcomes we would expect to see at times.
Investors prone to much media news watching are frequently conflicted when record high stock prices are reached. They are excited about the increased values of equity holdings but apprehensive that new higher prices could foreshadow a pending downturn and losses. Adding to their fear, the media’s “buy low, sell high” mantra may cause a reluctance to make new equity purchases as planned, keeping those funds “safe” in cash or Treasuries. That becomes a recipe for portfolio underperformance.
Financial journalists contribute to investors’ record-high anxiety by articles with analogies implying that the laws of physics apply to intangible financial markets—in other words, that what goes up must come down. “Stocks Head Back to Earth,” read a Wall Street Journal headline back in 2012.1 “Weird Science: Wall Street Repeals Law of Gravity,” Barron’s put it in 2017.2 And a Los Angeles Times reporter had a similar take last year, noting that low interest rates have “helped stock and bond markets defy gravity.”3
Those alarmed by such commentary will either shy away from systematic stock purchases as record highs continue, or worse, panic and begin selling at any sign of a market decline. But shares are not heavy objects kept aloft through strenuous management effort. They are perpetual claims on those companies’ future earnings and dividends. Thousands of business managers daily seek out projects they believe offer profitable returns on capital that provide goods and services they believe people will desire. Although many new ideas and businesses end in failure, years of history in the U.S. and elsewhere offers abundant evidence that people can be rewarded by supplying capital for a broadly diversified set of firms through intermediaries like Dimensional and Professional Financial.
Whether selling at a new high or a new low, today’s share price reflects investors’ collective judgment of all the knowledge out there about what tomorrow’s earnings and dividends are likely to be for firms in the financial markets—and what is expected from all their future tomorrows. Every day, every hour, stock prices adjust to deliver a positive expected return for buyers. Otherwise, trading will not take place. A scenario where prospective buyers voluntarily invest and expect to lose money at the same time is difficult to imagine.
Financial markets through the mechanism of trading impartially evaluates what is collectively known about future prospects and profitability of those firms traded. The market turns that information into share prices. For most investors who don’t understand the nature of “market efficiency,” getting a lesson from the Market for those with a contrary belief are rewarded only with an expensive education.
Experienced professionals treat record high prices with indifference, with neither excitement nor alarm. If stocks are priced by the markets to provide a positive expected return, a series of record highs even for an extended period is an expected outcome. Using U.S. historic month-end data over the 94-year period ending in 2020, S&P 500 Index simulations produced new wealth highs during more than 30% of those monthly observations. Moreover, systematically purchasing a broad stock index during extended periods with all-time market highs has, on average, generated similar returns to a strategy purchasing stocks only following a sharp decline. See Exhibit 1 over 1-, 3- and 5-year periods. Why does this happen?
Exhibit 1: Average annualized returns for S&P 500 Index after-market highs and declines
Past performance is no guarantee of future results. For illustrative purposes only. Index is not available for direct investment. Performance does not reflect the expenses associated with the management of an actual portfolio. S&P data © 2021 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.
Human minds are conditioned to extrapolate from recent past events in terms of physical movement. Too often an unconscious thought process leads to believing that after a strong rise in stocks or a stock, a fall must inevitably come. Fearing potential losses, investors are tempted to fiddle with their portfolios in order to lock in their gains (while also holding onto losers too long, hoping vainly to show an eventual profit). But timing signals exist only in investor imaginations. Efforts to improve results by futile timing usually penalize outcomes and create unwanted stress.
Be reassured, contrary to standard story lines, increasing share prices do not “fight” forces of gravity. Instead, record highs alone that we have seen over the past year, in the absence of other information, inform us only that markets are working just as we would expect—nothing more.
Using Headlines for Investing?
At some future day we cannot predict, U.S. stock market prices will stop rising and begin to decline dramatically. Valuations relative to stock prices, especially in the U.S., are at historic record highs such as before the Tech Bust in the late 1990s, as we wrote about in Planning Perspectives. An informed investment strategy will not make bets on the continued rise of growth stocks versus value stocks, or the rise of U.S. stocks versus those of other countries. Instead, a globally diversified portfolio with a balanced equity/fixed income allocation appropriate to your risk capacity and preferences can position most investors to profitably “dollar-cost average” during the accumulation phase of planning.
Somewhere some economist is being asked by some media commentator why now is or is not a time to invest. Most economists give predictions only because they were asked. Habitually reacting to media headlines leads to headaches at best and reduced returns at worst. Too much attention to your portfolio almost inevitably leads to pain and not gain.
Being uninvested to reduce or avoid paper “losses” for even a few wrong days can dramatically offset many years of positive returns, studies show. For marital harmony, it’s better to have a CFP professional to blame for what may appear to be—in the short-run—a disappointment. And while more than occasionally you may be disappointed with your statements, with the right advisors you can be pleasantly surprised with the long-term progress of a truly informed investment strategy and well-executed management process.
Rather than spend time and effort to guess when to invest or be invested, know what you can control and determine to stick with a professionally planned wealth planning strategy.
1Jonathan Cheng and Christian Berthelsen, “Stocks Head Back to Earth,” Wall Street Journal, February 11, 2012.
2Kopin Tan, “Weird Science: Wall Street Repeals Law of Gravity,” Barron’s, August 7, 2017.
3Russ Mitchell, “Tesla’s Insane Stock Price Makes Sense in a Market Gone Mad,” Los Angeles Times, July 22, 2020