S&P 500 record high: Should we be worried?
Posted April 1, 2013on:
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.
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