Editor’s Note: Starting on October 1, we are going to begin publishing Smart Money at 1 p.m. Eastern Time each day to ensure you have our latest analysis midday.
We hope this change helps you to make the most of all the opportunities Wall Street has to offer. Good investing!
Tom Yeung here with today’s Smart Money.
When stock markets hit fresh record highs, investors broadly separate themselves into two groups:
- Bulls: These daring investors see rising markets as a sign of even more gains to come. Time to buy.
- Bears: Others see record-high prices as inviting a correction. Time to sell.
Some of this stems from individual psychology.
We know that people with “internal locus of control” (i.e., a belief that they are in command) typically bet on numbers that have already shown up on a roulette wheel. They’re more trusting in “hot hand” theories, making new market highs a bullish signal.
Meanwhile, those with “external locus of control” (where outside factors like luck, fate, or other people are stronger influences) usually switch their roulette bets to numbers that have not yet shown up. They are more likely to avoid “hot outcome” bets and believe in mean reversion.
Another factor is experience.
Investors who learned their trade during a crash or financial crisis often see high prices as a cue to take profits.
We wrote here recently that older Japanese investors are typically more conservative for that reason. On the other hand, younger investors who began their investment careers after 2009 will have only ever seen “buy-the-dip” strategies pay off.
Regardless, the stock market’s recent highs have divided Americans almost equally down the center. Of people surveyed by the American Association of Individual Investors on September 17…
- 41.7% said they were “bullish” on stocks
- 42.4% said they were “bearish” on stocks
So, who’s right?
I’ll explore this question in today’s Smart Money… and share our course of action for market moves ahead.
What the S&P’s Record Highs Shows Us
To answer the question above, I’ve reviewed S&P 500 data since 1927 and recorded each instance where the U.S. index hit a new all-time high.
To prevent double-counting, record highs within 12 months of another one are ignored.So, if the S&P 500 hit a new record on April 4, and then another one on April 5, only the first date is counted.
That leaves us with 35 instances of new S&P 500 records from the past century. And here’s what the average return looks like over the following two years (roughly 500 trading days).
The graph above clearly shows an acceleration into a new record high, followed by a steady one-year return of 9.9% between trading day 0 and 252. Stocks then flatline for a while before returning to normal growth rates.
So, on average, buying at fresh record highs is great for your wallet.
That’s a point for bullish investors.
But we all know that simple averages can hide devastating outcomes.
