Market Peaks: What Happens Next?
When the equity market sets a new all-time high, many people become anxious about what will happen next. It turns out that new market peaks are common, occurring 1,144 times from January 3, 1928 through May 31, 2017, or once a month on average.
After a new S&P 500 peak, history tell us that 56% of the time the index goes on to make another new all-time high the very next trading day, and 42% of the time declines 1.6% before setting a new all-time high, less than a month later, on average. For an astonishing 98% of market peaks, the market goes on to another new high within a month.
S&P 500 PRICE INDEX POST RECORD HIGH CLOSES (January 3, 1928 – May 31, 2017)
Source: S&P Dow Jones Indices LLC
Of course, corrections do occur, but only about 1% of the time, and the market typically recovers within a matter of months. Since 1928, the S&P 500 experienced a correction only 11 times, with the most recent occurrence ending on July 2, 2016. Interestingly, the 1990’s contained 5 corrections. However, there were no corrections in the 2000’s, 1970’s, 1940’s or 1930’s.
Although rare, bear markets are far-reaching, and recovery periods are measured in years. At 10 occurrences since 1928, bear markets have been the least likely scenario after a new all-time high. Bear markets are also accompanied by serious underlying issues related to economic recession, inflation, asset valuation, government policy and other fundamental or structural problems. The most recent was the financial crisis of 2007, which was the second-worst bear market, with a 57% drawdown and took five and a half years to set a new high. While these events are emotionally wrenching, even the bear markets can be weathered and goals can be reached in a long-term investment portfolio by staying invested.
Around market peaks, people often wonder, "Is now the right time to invest, or should I wait?" It’s clear from history that waiting for a substantial decline in the market before investing poses a much larger risk of missing out on positive returns than can be offset by trying to avoid low probability serious negative returns. For long-term investors, the sooner and the longer the investment, the better the outcome.
From the Behavioral Viewpoint
What is going on?
- In a process known as anchoring, we become over-focused on a single data point, in this case a recent market peak, and assign it more importance than is justified. Since the overall trend of the stock market is upwardly biased, it is constantly reaching new highs.
- All the talk and chatter about market peaks and what will happen next creates an availability bias, that makes it seem like market peaks are an important factor that should be carefully monitored and considered. At an average occurrence of once per month, they are commonplace and have virtually no predictive value of a subsequent future loss.
- Investors have a strong desire to somehow know when is the right time to make their investments. This is a fallacy of control behavioral pattern, where we think we can manage or control situations that we have little ability to control or influence. The data in this case clearly shows there is little opportunity to determine the right timing of when to invest.
What can we do?
- The true drivers of long-term wealth are time and compounding. The best time to invest is as soon as possible. Investing early, making regular contributions and staying invested builds long-term wealth.
- Focus decisions on long-term plans and goals with needs-based planning and a disciplined process designed to fund and maintain a long-term investment approach.
- An experienced financial advisor can provide valuable perspective and coaching on when to take-action and how to stay on track by focusing on long-term goals and sticking to the plan.
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