The Difficulty in Calling a Market Top
What to do when the stock market is at an all-time high
Stocks hitting new all-time highs can be great if you’re already invested, but if you’re just entering the equity market or are considering adding to your portfolio, the recent market milestones might give you pause. After all, investing is all about the future, and if stocks reach an “all-time high,” what will that mean for tomorrow’s returns? After you climb to the top of a mountain, isn’t “down” your only option?
While this kind of thinking might be understandable, it’s also often short-sighted. Not investing – or even pulling your money out of the market – after the market reaches a new high is essentially calling a top in the stock market, fearing the market has nowhere to go but down. And while that’s certainly a reasonable initial reaction, especially amid troublesome economic and geopolitical headlines, making investment decisions based on fear rarely leads to the outcomes you want.
This Day in Stock Market History: March 28, 2013
On March 28, 2013, the S&P 500 reached a new all-time high, having skyrocketed 132% from the depths of the Great Recession. But there were reasons for concern: Earnings growth, unemployment and housing hadn’t come close to recovering from the financial crisis, and the European debt crisis and U.S. budget crunch were front-page news. There were many reasons to think this new market high would be short-lived.
With the benefit of hindsight, though, we know how the story ended: Since reaching a record high on March 28, 2013, the S&P 500 has roughly doubled alongside the longest economic expansion in U.S. history, rewarding investors who stayed in the market.
“Timing the market” – the investment strategy of buying-in when the market is at its lowest and selling at its peak – requires near-perfect foresight to succeed. Since 2012, there have been more than 230 new “all-time highs” in the S&P 500. Each of these moments was the “market top” for a brief time, and each was accompanied by worrisome the-end-is-near headlines. But selling on any of these days would have prevented you from participating in the next new high, and the new high after that. And with so many new market highs during this bull market, an investor would have less than a 0.4% chance of correctly identifying the actual top.
Plus, for market timing to work, you have to be right twice – not only when to get out, but when to get back in. It’s not only highly impractical, as trading costs and taxes would certainly eat into any profit, but it’s also nearly impossible to accomplish.
That’s why we recommend a well-diversified portfolio as a core piece of any financial plan. It mitigates the risks that come with trying to time the market, and it lets you take advantage of pockets of the market (stocks, sectors, etc.) that have not yet reached new highs. Research tells us that investing a lump sum, even near a market top, often beats most other strategies given enough time.
There’s an old investing adage – Bull markets don’t die of old age. Instead of calling a top or trying to time the market, we believe you’ll be better served by talking with your Baird Financial Advisor about your priorities, creating a sound investment strategy and getting your money to work as soon as possible.