New stock market highs aren’t that special. Here’s why.
Some people inaccurately believe that any time the stock market reaches a new high it must mean that we are near a peak, and it’s a sign that stock prices will probably fall soon. Many undisciplined investor may choose to pull out of the market when this happens. However doing so will almost always be the wrong decision. This is because stocks reach new highs all the time. And they usually go up even more in the following years.
This Bloomberg article explains that over the past 102 years from 1915 to 2017, the Dow Jones stock market index in the United States had hit 12 new highs every year on average. 🙂 That’s once per month. Another way to think about it is that the Dow experiences a new record high about 5% of the time. So it’s not really not that rare. 😉 The table below shows how the frequency of new highs are distributed over the decades.
If someone starts investing at age 30 and plans to live until 80, then he’ll have 50 years of time to invest in equities. Based on historical data for the Dow Jones, he will see roughly 600 new record highs during his investment duration. This is why selling stocks because we may have reached a new peak in the market is a very silly thing to do for long term investors.
Trying to sell high and buy low rarely works. Again, the facts clearly explain why this is the case. Over the same time period, (1915 to 2017), the one year average return for the Dow after it had reached an all-time high was 9%. The 3 year cumulative return was 21%, and the 5 year return was 32%. So even when stocks are at all time highs, they tend to move even higher in the years after. 😀
However, this doesn’t mean we shouldn’t prepare for the next recession or financial crisis. When historical valuations for companies are low, the average stock market pull back is only 6%. But in past situations like today, when stocks have been in the most expensive quintile of historical valuations, the average correction is 33%.
This is why I’m maintaining a 35% safety buffer in my margin trading account. My portfolio will have to drop in value by 35% before I get a margin call. But since historical evidence shows that the market is somewhat likely to deliver 32% positive return over the next 5 years, I’m not too worried. 😉 Using leverage while giving myself adequate liquidity insures that my portfolio should continue to outperform the index if long standing historical patterns continue, but I won’t lose my shirt in the case that they don’t. 🙂
Random Useless Fact:
Chess was invented in the 6th century.