By: Sarah K. Charles, CSRIC™, AIF® / Director of Business Strategy and Bill Laird, CFA®, CFP® / Chief Investment Officer
Ain’t No Market High Enough
Sarah K. Charles, CSRIC™, AIF®
I am acrophobic – which is the fancy way of saying I have a fear of heights. Now whether my fear is genetic (my mom is acrophobic) or is the result of being pushed off the top of the jungle gym by a boy in my class when I was 7 years old and plummeting to the ground and conking my head on a metal pole (traumatizing events involving heights are also a cause) I have no idea. But the combination of my DNA and a young boy’s misguided attempt at childhood love is why I will never walk out on that glass bridge that overlooks the Grand Canyon, and why I find the Ferris Wheel to be the most terrifying ride at the amusement park – even more so than roller coasters. At least on roller coasters I can close my eyes and enjoy the physical sensation of being whooshed through the air, but Ferris Wheels move at the pace of sap dripping out of a tree, and the little car is always (ALWAYS) swaying back and forth, and at each and every painful stop all I can do is look down and see the incalculable (and growing) distance between me and the ground.
Fear of heights is common. In fact, it is one of the most common phobias around, afflicting about 5% of the population. But the fear I am most interested in these days is fear of highs – fear of market highs that is.
It doesn’t have a name, and I have no idea how many people suffer from it. As for what causes it…if I had to guess where a fear of market highs stems from, it’s this: the fact that the basic rule of investing is “Buy low. Sell high.” A pretty straightforward concept even if it’s not always easy to adhere to. But when markets hit new high after new high after new high (as they have done for much of 2021) it leaves many investors wondering: is now a good time to invest? If we’re supposed to be selling high, isn’t buying now, after another new high, an obvious mistake? Isn’t deploying capital in a rising market a violation of one of the most fundamental principles of investing?
For starters, the general purpose of investing money in the stock market is because you believe the shares you purchase today will be worth more at some point in the future, and you are looking to grow your wealth over time. So, of course you don’t want to pay a premium for an investment (i.e. buy high), only to see value wiped out when the investment declines in value. But why do we assume that what goes up must come down? And for that matter why do we behave as if markets have limits?
Markets aren’t a financial Mt. Everest – there is no summit or peak that indicates we’ve reached the ABSOLUTE top. Think about what powers markets. Investors base their decisions to buy or sell a stock on company fundamentals*. If a company is innovative and successful – develops a new product, sells more widgets, acquires competitors – then it will generate more revenue and grow profits and when it does, buyers are theoretically willing to pay more for shares of the company’s stock which drives the price up and which pushes markets up. It’s the basic law of supply and demand, and it is why markets have seemingly unlimited capacity to contract and expand over time.
* Speculators on the other hand are generally uninterested in fundamentals and more interested in who will pay them more for whatever trade they just made
So how successful can any one company get? On August 2nd, 2018, Apple became the first U.S. company to hit a $1 trillion market cap (market capitalization is defined as the number of outstanding shares x price per share). Since then, four other U.S. companies (Amazon, Microsoft, Alphabet (Google’s parent company) and just recently Facebook) have also reached the $1 trillion threshold. But what’s really interesting is the time period needed to accomplish this feat. It took Apple 37 years before it reached $1 trillion. Microsoft? 33 years. But Facebook managed to join the club in just over 9 years after going public. And even more interesting is that while Apple and Microsoft each took over 3 decades to reach their first trillion, they both doubled in size to $2 trillion in only 2 years.
There’s no limit to any company’s ability to grow which means there is no limit to how high markets can go, so a new market high shouldn’t be treated as an automatic indicator that we’re getting ready to fall off a proverbial cliff.
Which brings us back to the idea that what goes up must come down. To be fair – if we’re talking about physics then yes – the laws of gravity apply. But investing isn’t governed by gravity, or by any laws of physics for that matter.
Exhibit 1 shows the 1-year, 3-year and 5-year performance of the S&P 500 after both a new market high (the blue bars) and a market decline of 10% of more (the green bars). As you can see, in all instances, the average annual return was positive and, in most cases, was double digits. In addition – and what I think is most noteworthy – is that these annualized rates of return are nearly identical regardless of whether we had experienced the euphoric bliss of a new market high or the gut-wrenching agony of a meaningful market decline.
This is not to say that markets only go up. Based on the same time period in Exhibit 1, if we look ahead to the first year following a new market high, the S&P 500 was higher 81.6% of the time – which means 18.4% of the time it was lower. Looking out 3 years the index was higher 82.5% of the time and 5 years it was higher 77.8% of the time. So, there will be times when “what goes up does come down” but more often, market highs beget new highs which raises another important question: just how often do these market highs happen?
Well, between January 1st, 2021 – June 30th, 2021, the S&P 500 has closed at a new high 34 times. And while you might think that this is astonishing or unusual, it is actually neither.
As you can see in Exhibit 2 (which documents through June 29th, 2021), new market highs aren’t the total solar eclipse of the investing world. They are more like the Pleiades i.e., they tend to happen in clusters. And not only do they happen in clusters, but those clusters can last for years. Since 2013, the market has hit a new high 309 times.
One thing that’s striking about the current run of new market highs – they are happening during a particularly dull market. For the first six months of the year the average daily price change in the S&P 500 has been +0.68% on up days and -0.60% on down days, and the index hasn’t had a 5% correction based on closing prices since the end of October 2020. So, these new market highs aren’t happening after days with big wild swings in the market. They are occurring on ordinary days when the market is moving a few basis points here and a few basis points there. The last high of the second quarter? Came on a day when the market was up all of 0.13%. The day before? We set a new high after only a 0.03% gain. No one writes a news story touting a 0.03% gain for the day – but they do write about the day if it results in yet another new market high.
While this non-headline generating activity is the best backdrop for long-term investors, it’s certainly not what you’d expect in a year where the headline has been “markets closed at new highs today” 34 times in 6 months.
Something else to consider: so far we’ve been talking about the S&P 500 – which is the index that is most often reported in the media along with the Dow and the NASDAQ. However, we take a globally diversified approach to building portfolios because the investable universe is a lot bigger than 500 large U.S. companies. The S&P 500 is only one slice of the pie and while it may continue to hit new highs, not every asset class in your portfolio is breaking records.
Knowing that different asset classes are in favor at different times is one of the reasons why we periodically rebalance your accounts. As certain asset classes continue to outperform over time, your portfolio can drift from its target allocation and so rebalancing (i.e., selling from the funds that have outperformed and reinvesting them into funds that have underperformed) ensures that you’re always invested in a way that’s aligned with your risk profile. Rebalancing is also a surefire way to stay disciplined as an investor. The idea of “Buy low. Sell high.” isn’t about reaching a particular peak or threshold. It’s a principle designed to keep humans from falling prey to their natural behavioral tendencies by stripping emotion out of the investment process and providing a structure to inform decision-making.
Finally, investing is a long-term endeavor. Even clients in retirement often have a time horizon of at least 20 – 30 years ahead of them to be invested. But it can be easy to lose perspective – especially when the media is focused on the legion of day traders turning to social media forums and chat rooms for the latest swarm trade or short squeeze.
I’ve said it before, and I will say it again (and again and again and again): what matters most is the progress you’re making towards your personal goals – not the progress of the markets. And your DHGWA Strategic Life Plan should be the framework you use for navigating your financial decisions – not headlines.
So, our advice? Turn off CNBC and crank up Diana Ross (or Marvin Gaye and Tammi Terrell) “Cause baby there ain’t no market high enough…”
Q221 Market Perspective
Bill Laird, CFA®, CFP®
Not only were investors presented with anecdotal evidence of rising inflation (lumber prices surged to all time highs in May before retreating by over 40% in June) they were told by the financial media how to combat inflation inside of their portfolio by buying significant positions in cryptocurrency or gold - both of which dipped significantly during the quarter. Both equities, which continued their broad advance, and fixed income contributed to positive portfolio returns during the second quarter. Most of the quarterly returns from fixed income came from price appreciation of bonds which were the result of continued reductions in market interest rates – a trend which picked up steam beginning in May of this year after an advance from lows in the fall of 2020. Interest rate declines came as a shock to any investor who reads the mainstream financial media where the word inflation has dominated headlines.
As illustrated in Exhibit 3 below, the fact is, many things will cost more tomorrow than they do today, making inflation an insidious force and something that individuals should plan for – relying on advice from their advisor and not the media.
In U.S. dollars. Source: http://en.wikipedia.org/wiki/History_of_United_States_postage_rates
Planning for inflation involves taking appropriate risk to tackle costs that are bound to rise in the future, and the overall risk that our clients take is primarily correlated with the percentage of their portfolio that they have in stocks. Stocks are risky assets that over long periods of time can provide returns that outpace inflation. Additionally, we employ diversified portfolios that participate in all sectors of the economy, including those that tend to benefit from rising costs like industrials, commodities and financial stocks. At DHGWA, inflation is always a consideration when building our client’s portfolios, not a hasty afterthought when the headlines start getting exciting.
Finally, we are also judicious in building our clients’ risk buffers which primarily consist of bonds. Our portfolios hold securities in all sectors of the bond market in the US and worldwide and vary by maturity (short-term, intermediate-term) and coupon (some fixed, some floating rate) to ensure our portfolios are as durable as they can be when inflation ebbs and flows.
In a classic article that appeared in Fortune magazine in 1977, Warren Buffett outlined his views on inflation:
“The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital. ... If you feel you can dance in and out of securities in a way that defeats the inflation tax, I would like to be your broker — but not your partner.”
As a fellow value investor and disciplined “broker” our feelings on inflation align well with Mr. Buffett. Inflation is a long-term enemy to be planned for but should not drive significant short-term adjustments to your long-term plan or portfolio.
Markets aren’t the only thing setting records these days. A record-setting heat wave has blanketed the Pacific Northwest, multiple world records were smashed in both the U.S. swimming and U.S. track and field Olympic trials, Phil Mickelson became the oldest golfer to win a major golf tournament, and at the end of May, Simone Biles became the only female gymnast to attempt and successfully complete a Yurchenko Double Pike during competition. While we don’t have a crystal ball to speculate on whether the market will continue to set new highs heading into the second half of 2021, we wouldn’t be surprised to see more world records set in Tokyo as the world’s best athletes take the stage at the 2021 Olympics.
Stay cool out there and take care.
The information in this article should not be considered investment advice to you, nor an offer to buy or sell any securities or financial instruments. The services, or investment strategies mentioned above may not be available to, or suitable, for you. Consult a financial advisor or tax professional before implementing any investment, tax or other strategy mentioned herein. The information herein is believed accurate as of the time it is presented, and it may become inaccurate or outdated with the passage of time. Past performance does not guarantee future performance. All investments may lose money.