To hear Wall Street say it, everything is rosy again — and the cautious naysayers are looking like a bunch of Chicken Littles, suckers, and sore losers. Yet again.
Yes, the stock market is off to the best start of the year in more than three decades.
Yes, the Dow Jones Industrial Average
has rocketed more than 2,000 points since Jan. 1, and jumped another 360 points on Tuesday. The Standard & Poor’s 500
has risen 10% so far this year and the Nasdaq Composite
have gained 8% each, Amazon
27% and Netflix
And yes, those sitting on the sidelines in too much cash have missed a quick rally. As money manager Josh Brown, CEO at Ritholtz Wealth Management, reminded investors again this week, if you miss the handful of best days on the stock market, you miss out on a huge chunk of the long-term returns.
So is that it? If you’re under-invested in stocks, should you be kicking yourself?
Not so fast.
Sure, hindsight is 20-20. But if you’ve been too cautious of late you’re not alone. And here are five reasons why you weren’t not dumb — and you may be proven right.
1. You haven’t really missed that much
Sure, if you’d bought and held you’d have been sitting in stocks during the boom since Jan. 1. But you’d also have been sitting in stocks when they tanked last quarter. The Dow has risen more than 2,000 points this year, but it fell more than 3,000 in the fourth quarter. Even after the rally, the Standard & Poor’s 500 is still 6% below last September’s peak. The average level on the S&P 500 during 2018 was 2,744, says FactSet. The level today: 2,745. It’s a wash. Meanwhile, the rest of the world has done even worse. The MSCI All Country ex-US index
is still 12% below its 2018 average.
2. Don’t be fooled — nothing has really changed
Stock markets around the world plunged last quarter. The Dow fell more than 3,000 points, and the MSCI All-Country World index
dropped nearly 14%. Wall Street experts argued there were some good reasons: Economic slowdowns in China and Europe, rising interest rates, trade war fears, looming conflicts between a Democratic Congress and President Trump, and weaker corporate earnings. Today? Economists and other observers agree most or all of this is still happening. Corporate earnings may be heading towards a recession. As for interest rates: Yes, U.S. Federal Reserve chairman Jerome Powell has put short-term rate hikes on hold, but most economists say the key figure in finance is the rate on 10-year Treasury notes, which he doesn’t control. That rate on Dec. 31: 2.69%. Today it’s 2.69%.
3. You were on the sidelines for good reason
The S&P 500 has only just — on Tuesday — got back level with its 200-day moving average, after spending two months below it. For anyone concerned about risks, as well as returns, this is a key number. Financial historians have found that since 1900 one of the most sensible things any long-term investor could have done was to stay clear of U.S. stocks when the S&P 500 was below its 200-day moving average. That would have saved you the worst bear markets, while keeping you invested during most booms. You’d have actually ended up making more money, for a lot less risk, than someone who bought and held. FactSet data shows it’s also been true, for example, in the Japanese bear market since 1989: While the Nikkei 225 remains barely half its 1989 peak, someone who was in the market only while it traded above the 200-day moving average would actually be heavily in profit over that time.
4. You’re smart not to discount the current risks
From the viewpoint of long-term investment, major risks remain according to some long-term strategists. Yes, conventional wisdom on Wall Street tells you that stocks are likely to gain an average of around 9% a year. And yes, that’s based on the historic average going back at least to the 1920s. But, say some financial historians, that’s a misreading of the past. Stocks, they say, typically produced “average” returns if you bought them at roughly “average” valuations in relation to things like net assets and net income. And U.S. stock valuations today, they warn, are anything but average.
According to price-to-earnings or “PE” data tracked by Yale University finance professor and Nobel Prize winner Robert Shiller, the S&P 500 is about 75% above its historic average valuation. “Ten-year forward average returns fall nearly monotonically as starting Shiller P/E’s increase,” warned hedge fund manager Cliff Asness of AQR in a 2012 research paper, as he studied the S&P 500 going back to the 1920s. Also, he added, “as starting Shiller P/E’s go up, worst cases get worse and best cases get weaker.”
Today’s level? Compared to history, we’re in the most expensive 10% of starting valuations, according to Asness’ data. “Average” 10-year returns from here? Based on history it’s about 0.5% a year after inflation, he calculated.
5. Many big ‘up’ days take place during bear markets
Yes, certainly, the biggest “up” days on the market have historically accounted for a big chunk of long-term returns. “One of the most common rhetorical bulwarks in the defense of buy and hold investing is to demonstrate the effects of missing the best 10 days in the market, and how that would affect the compounded return to investors,” Cambria Investments manager Meb Faber pointed out in a recent research paper.
But, he warns, “This is perhaps one of the most misleading statistics in our profession.” The reasons? Most of the biggest “up” days took place during bear markets, when the smart move was to be on the sidelines, he says. Oh, and missing the worst days was just as good for your wealth as catching the best ones, he found. From 1928 through 2010, he calculated, the 1% best days gained you, on average, 4.9% each. What about the worst 1% of days? They cost you about 4.9% each.
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