The Investment Scientist

S&P 500 record high: Should we be worried?

Posted on: April 1, 2013

New York Stock Exchange

New York Stock Exchange

The S&P 500 closed the first quarter at a record high. Should that worry investors? The short answer is, No.

When the market was 30% below the high three years ago, I did some research. I categorized all market conditions into:

1. Breaking a new high.

2. Less than 10% below historical high.

3. Between 10% and 20% below historical high.

4. Between 20% and 30% below historical high.

5. Between 30% and 40% below historical high.

6. More than 40% below historical high.

Then I calculated the one year forward returns of the six conditions.

The contrarian in me expected to see a linear relationship: the further away from the historical high the S&P was, the stronger the one year forward returns would be.

Boy, was I surprised! Other than condition 6, there are no statistically significant differences in return distributions between conditions 1 through 5.

In other words, the fact that the market is breaking a new high does not by itself change the return outlook – as far as historical data can tell us.

So what’s the true danger of the market reaching a new high? Alas, mostly psychological.

We humans are conditioned to remember the last thing best. The last thing that has happened to the market is that it has gone up, up and up. This may lead our human minds to discount the possibility of a market fall and over-expose us to the market. In 2000, there were people who sold their houses to invest in the market – just in time for the market to fall and the real estate market to boom.

The best way to guard against human frailty is to have an asset allocation plan and always stick to it no matter what the market does.

Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.

3 Responses to "S&P 500 record high: Should we be worried?"

Michael, I don’t know all of those calculations. It seems to me if you were a buy and hold client holding an indexed mutual fund, after 5 years your just a little better off than where you started, minus inflation and fees. There would be no reason to ever invest if now is the time to leave.

If the productivity and leverage companies have created through robotics and labor reduction is real, then there is more upside.

If we listen to all the fear mongers, with a book or tip sheet to sell, we would all sell off, by gold, and look at it everyday while it sits there, hoping for a good selling point. No dividends, no interest, no cash flow.

My opinion; the productivity from robotics is real. Technology is a job killer, and there is no FICA or labor tax on robots. Further, the internal leverage created by the large scale layoffs is real too. It reduces the variable costs in making a product. That lowers the break even point for the business. The result of lowering the BEP is a 10% rise in sales may mean a 50% or more rise in profit Thus, the earnings reports across the board are largely very good.

The show stoppers I see are the masses being out of cash and unable to purchase and there is some of that, but 75% of the people are still working. The elephant in the room is Ben Bernanke. The fiat currency he is pumping in shows up first in the market. When he makes a move to raise interest, the markets will respond.

My thoughts are the S&P500 may go another 20% with fits and starts along the way, people are still nervous. Keep an eye on your trailing stops, and when you reach your goals for each individual holding, adjust.

Ron,

Actually my clients are doing better after five years. Here is why …

1. Dividends – about 3% a year that are disregarded in the index.
2. Discipline rebalancing – which requires balancing into equity when the market falls. So I was indeed buying low and selling high for the clients. This adds another 2%。
3. Small cap value tilt – though SCV fell a little harder than big cap, it came back much stronger and it creates much better rebalancing opportunities. This adds another 2% a year.

These are the major. There are some minor ones like securities lending done on the fund level that juice the returns.

Everybody can have an opinion – and your know I always value your opinion, particularly when it comes to RE investment. But not all opinions can be tested against data. I disregard those opinion. I only act upon ideas that can be and have been tested.

You have a great advantage in having an education in the business. My advisor follows similar strategies with the roughly 1/3 of my holdings he cares for. I was only pointing out, or trying to, that had a person stayed with it after the crash, he would be roughly even. If they left because of fear, they have missed the biggest part of the recovery. If they were fortunate enough to have cash to buy with in mid 2009, then anytime would be a good time to sell.

Risk tolerance is a real thing. My observation is the markets still have a great deal of fear in them. One wouldn’t think a tiny little country like Cypress would have an impact, but the financial world is so very wired together that any little burp has an impact. I would guess if you had money parked in a Cypriot bank, it would have a big personal impact.

If seazing assets through a “one time tax” becomes another acceptable way to save those that are too big to fail worldwide, then suddenly there is no reason to work toward excelence. It seems like everybody gets a haircut except the guy holding the clippers.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



You may also get his monthly newsletter, or join his Facebook page for regular wealth management insights. Michael's email is info[at]mzcap.com.

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