The last 10 days have seen the stock market march consecutively higher. Since the presidential election, the Dow Jones Industrial Average is up more than 13%. As investors analyze their statements, they often encounter a nervousness as they appreciate the increase in values, but recognize that stocks cannot go up, unimpeded, forever.
Amidst this backdrop, we faintly recall that ten years ago the stock markets were cresting and a 60% decline was on the horizon.
It is a lot to digest.
Some investors have thrown caution to the wind while chasing returns. They often fail to understand that many traditional valuation metrics are currently in their 80th or 90th percentile. This can be when our memories are too short or we allow greed to push us into questionable decisions.
Some of our clients question whether the markets will continue their assault on the record books or if we are due for another sharp decline.
The truth is: I simply don’t know. In fact, anyone who says they do know is merely guessing.
Instead, there are a few lessons that offer an investor a fighting chance:
First, successful stock market investing requires the ability to shut out the short-term and focus on where you want to be 10 or more years from now. I have no idea what will happen in the market at any point during the next year. However, I am pretty sure that over the next 10 years the stock market will be higher. Ten years is a good time frame for investing in volatile assets.
Next, don’t be too quick to count your chickens until they have hatched. Many investors are already factoring in the benefit of potential tax cuts and fiscal stimulus under the Trump administration. If successful, this may boost corporate profits and push stocks higher. This tremendous optimism is already reflected in prices and valuations, and therefore adds risk going forward.
Furthermore, regardless of how optimistic you may be, when investing in a stock, one must always recognize you are buying a business. You invest in it because of its ability to generate profits over long periods of time. That is what gives it value. However, rarely does a stock’s price equal the value of its earnings.
Regardless of the earnings of a company, the stock price will always be volatile. This bumpy ride must be tolerated if you want the long-term benefits. Since 1980, the S&P 500 Index has fallen more than 14%, on average, during each calendar year. Despite this, the stock index has still produced positive returns by the end of the year 75% of the time.
This magnitude of volatility has certainly been felt since 2009. After the market bottomed, the stock indices have fallen more than 10% on five occasions, even though we are enjoying a 90 month economic expansion. Recall that just a year ago the markets were down 13%. However, we continued to rebound, producing respectable returns for the year.
Any stock investor should be prepared to encounter such a decline with great regularity. Once prepared, you realize that volatility can actually help you with long-term returns.
Valuations always matter. The higher the valuation an investor pays, the lower the future returns will be. Valuations are rich, but that should not dissuade an investor from continuing with their long-term plan or adding to their investments.
If you want to earn the averages, you have to stay invested. Attempting to time the market is a fool’s game. After the steep decline of October 2007 to March 2009, it took a full five years for stock indices to get back to break-even. However, you had to stay invested to get there. The really smart investor continued to add to their nest egg during the turbulent times.Recognizing this, one of these days the market is going to be crazy and unpredictable again. It will be scary and supposed experts will predict doom and gloom. It has always been that way, and modern news media has only made it worse. As such, know what your long-term game plan is. Focus on where you want to be 10 or more years out and then have the discipline to see it through.