The stock market is too high!
Every time the market hits a new all-time high, many investors and pundits inevitably begin expressing their belief that we must be close to the "market top." Of course, they're implying that a decline must be on the way as if new highs are signs of imminent doom.
There’s a unique irony in that belief because it stands in complete opposition to the entirety of our investing lives.
Here's what I mean: If you were to review a chart of the S&P 500 from 1950 to now, you would see that it has grown from a price of 16 (that's not a typo!) in 1950 to today's high of around 5,600. Clearly, market highs are not something to fear. At least, that’s the long-term view.
Now, if we zoom in and look closer, we can see that along that growth chart, there have been 39 market "corrections" of 10% or more, including 11 bear markets (which are declines of 20% or more). Yet, despite those 39 declines, there have been more than 1,250 new all-time highs, which have served as highlights on the market’s path from 16 to 5,600 (a fact so incredible that I feel compelled to mention it again).
So are all-time highs risky as some people seem to think?
I believe the long-term data speaks for itself but to go another step, Royal Bank of Canada (RBC) did a study that found in the year following a new all-time high there were 10% declines just 9% of the time.
While stats from the past may not help us predict the future, I do think they offer a helpful historical perspective for anyone who believes that all-time highs are a sign of pending doom.
That said, it is human nature to want to know when a market decline will arrive. We naturally want to protect ourselves, but making investing decisions as if a decline is certain is a bigger risk than most people realize.
One of my favorite quotes on this topic came from legendary investor Peter Lynch who said,
"Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves."
Don't be like Harry Dent
For a great example of the risk Lynch notes, there’s a gentleman named Harry Dent, who has been issuing apocalyptic predictions for the last 15 years, even going so far recently as to predict a looming 86% decline.
Yikes!
Unfortunately, the sad result of his long-term pessimism and wildly incorrect predictions is that his followers have probably lost untold millions (or billions) by missing one of the greatest bull markets of all time. Ironically, by trying to protect their capital. So much for that!
I’m not saying that I know what will happen next. I don’t, nor does anyone else, regardless of how confident they may sound. But we can learn from the experience of Dent's followers and the data noted above.
I think the right lesson is that historically speaking, selling in anticipation of a possible market decline is more likely to be a source of long-term risk rather than the avoidance of it.Just as Peter Lynch said 30 years ago.