All-Time Highs Should Excite Us, Not Scare Us
It’s not uncommon for investors to be hesitant or even afraid to buy stocks when they or the market is at an all-time high. This is a great time to invest, and the numbers prove it.
It’s not that clear where the fear of buying at the top comes from, but there are a few things that may weigh in on an investor’s decision to buy or hold off during the headier times, like right now for instance.
With stock markets making more new all-time records, and with the great year that we’ve had overall with long positions in stocks, a lot of investors are sitting with big positions in cash. This includes some very wealthy people, and asset managers that manage the portfolios of very high net worth individuals are reporting some huge numbers here.
It seems that a lot of people are hedging right now, more than usual and certainly a lot more than we saw during the earlier phases of this decade long bull market for stocks. It doesn’t make sense to hedge more during the good times and especially during the very good times, but this often isn’t realized or understood properly.
There are two main types of hedges, the one that protects you against black swan events that you cannot otherwise manage, and hedging that seeks to be proactive and protects against risks of a more gradual nature and ones that can be managed through other means, and more efficient ones at that.
We don’t want to put too much weight on the far side of bad, which would involve true black swan events, ones that not only happen out of the blue but involve not either being able to manage the losses that result prior to or even afterward.
We could have a terrible day where the market loses a huge amount, a day that we would put black in front of, and we’ve had 2 days that have resulted in about a 10% loss each back in October of 2008 at the height of the financial crisis, and at a time where it was not even clear that we would survive.
Few people have any idea of the magnitude of the risk out there back then, and we were just days away from the collapse of the entire world banking system without the right action. These two days ranked fifth and sixth in terms of the biggest percentage losses in a day for stocks, eclipsed only by four days during the period of 1929-1933.
We didn’t just have the risk of widespread bank failure, we actually had it back then, with a third of banks going under while the Fed stood by and watched with their hands in their pockets.
The risk was actually considerably higher in 2008, but unlike during the other huge move down, the government stepped in and saved the day. By the time we got to October though, anyone who didn’t realize that stocks were in trouble well before this must have lived in seclusion. Perhaps if someone does invest in stocks and goes that much off the grid, they would need to be much more careful, but we don’t want to hedge to make up for a lack of proper attention or any attention in this case.
When We Hedge in Bull Markets, We Just Hedge Our Returns
Neither the crisis that started in 1929 or the one in 2008 came out of nowhere, and far from it in fact. It’s possible that we could see an event so bad that we could go from a party to a wake, things like global nuclear war, but we would have much more to worry about besides our portfolios declining if such a thing ever happened.
There are some bearish trends that we should be afraid of though, and quite afraid, but to act like it’s a bear market when we are actually in a bull market should strike us as bizarre. It is not always easy to tell whether a decline is a temporary thing or a more lasting one, or even what point that we should jump off, but when we are making all-time highs, this is as far away from such a moment as we could possibly be.
There has been a lot of this hedging that has gone on this year, and people are entitled to do whatever they wish with their investments, but we need to understand that if the good times are replaced by the bad times, the bad times will come knocking first and we will have plenty of warning.
This brings us to the next concern, that an inflated market will burst like a bubble, like we saw in 2000. As stock prices continued to rise in the late 90’s, it was no real secret that we might be in for a serious downward move. Even that was pretty well telegraphed, and we got to the point where the party simply ended and we moved down. The decline happened over a two-year period and all of it but the very tip happened at a time where we weren’t worrying about the bubble bursting, it had already burst.
When you come off an all-time high and then things turn sour, that’s entirely different than the same thing without any sourness. Whether you want to hold on to stocks when they sour, or how much sourness you want to endure, this is not the same thing as seeing the monsters before they ever appear and when the skies are rosy.
There are traders who have moved in and out of positions in 2019 dozens of times, hundreds of times, even many thousands of times, but it hasn’t been because the market itself has turned bearish. There are bull and bear markets that happen throughout the year, and even throughout a day, but this is far from the scope that investors need to be focused on.
As investors, we should be looking at periods like the next 12 months to form our overall view, and this applies to both the period that we are looking at generally and the expected time horizon for our positions. If we know that we’re probably going down over the next 12 months but things will recover over the next several years, it would be stupid to hang around for the storm just because we’ll recover.
What we want to do instead in this case is to step aside, and there are times where investors should be stepping aside even though they may believe or may be told otherwise. When the skies clear and the outlook for the next year improves enough to make being back in stocks a winning proposition again, we can get back in, but if the forecast calls for rain and we don’t want to get wet, we either get out of the rain or get soaked.
There really isn’t anything that scary out there right now, and one of the ways to really tell is to look at how stock indexes are doing. If they are making all-time highs, then you know just from this that the sky is very likely clear, and very likely is more than enough confidence and more than we usually have in other situations.
If there really were things to worry about, this would be priced in, like how we stepped back when the trade war deteriorated more. This issue is looking better now, with nothing else really weighing on things, so the all-time highs that we got last week show us that the market really does have its ducks in a row, or we wouldn’t be here.
There Are No Better Entries Than at All-Time Highs
This should actually be obvious, although when it comes to worry, we don’t always think as clearly as we should, and there are people out there with various degrees of worry as the market keeps moving forward. We do have data from the S&P to back this up, as they have studied this over time and have discovered that when we make an all-time high, the average return over the next year is 12.34%.
The decision then becomes between whether we want to take advantage of this 12.34%, or pass on it. The 12.34% number is actually a lot higher these days as this research went all the way back, with most of this period consisting of much more minor moves than we see in the modern age. The choice then becomes between choosing 12.34% or more, or getting peanuts from whatever else you could put the money in.
This should not be a difficult choice, once we realize that there is never a time where it is more certain that you will get a good return than when the market is at an all-time high.
The same has proved true for individual stocks as well, and once again, not surprisingly, given that we seek positive momentum and stocks at all-time highs definitely have plenty of that. Cambria Investment Management has studied individual stocks at all-time highs and discovered that they do better overall than your average stock.
An all-time high is something that not only should not be feared, it should be celebrated, and if we are ever going to dig in between the cushions to invest, this should be the time.
Chief Editor, MarketReview.com
Ken has a way of making even the most complex of ideas in finance simple enough to understand by all and looks to take every topic to a higher level.
Contact Ken: ken@marketreview.com
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