Stock Market Performance in the Periods Following All-Time Record Highs
This is the second in a two-part blog of our Quarterly Investment Committee Briefing.
On August 15, several of the major U.S. stock market indices reached all-time high levels. The Dow Jones Industrial Average, the S&P 500 and the Russell 3000 all closed at record highs, welcome news for the average stock investor who has patiently invested for the long-term.
But many ask, “Does the fact that a stock market index breaks through to an all-time high suggest that the market is at a precarious level?” It can be tempting to compare a stock market at its all-time high to standing on top of a tall mountain — it’s a lofty height with nowhere to go but down. But is this an accurate analogy?
A monthly survey of professional investment managers taken on September 2, just after the markets breached their record highs, suggests that this analogy might be a common belief in the industry. Fifty-four percent of the 208 money managers surveyed believed the stock markets were overvalued — the highest reading in that monthly survey since mid-2000. These managers held these beliefs despite reporting a view that global economic growth expectations are improving and a strong view that interest rates may continue to be held low by global central banks.
Now, one might say that this is just a coincidence; there are things going on right now that might make managers nervous about stocks. The September survey said managers cited some concerns, such as “vulnerability to a bond shock” and even “a Republican win in the White House in November.”
To check whether managers thought the same way the last time the market breached an all-time high, we took a look at the same monthly survey from April 2015, just a couple of weeks before the stock markets breached their then all-time high (in May 2015) and we saw that the same survey had almost the same message. Indeed, the survey drew the exact same conclusion then that they did in this most recent survey — stock managers who seemed to be finding stock markets to be overvalued were again at the highest plurality in their survey since 2000.
Clearly, this may not be a simple coincidence, and this investment reaction is common in both investors and professionals. When markets break through to levels never seen before, folks get nervous that the market rally may not last.
So, we asked, “Is this truly the case?” We started our investigation by picking a stock market index with the longest track record of daily closes, namely the Dow Jones Industrial Average. We identified every time the Dow crossed into record territory on a daily basis, looking all the way back to 1896. We took care not to identify “spurious” records, such as when the market again breaks to a record high any time within one month of having just reached a record high.
Our analysis showed that there have been 105 times in the 120-year history of the Dow when the market reached a new record high. So how does the index perform in periods after reaching a record high, as compared to how the index performs on any other normal day (record-high days removed)?
As we can see in the table above:
- In the first few months, the performance of the market is a bit weaker after it has reached a record high than it is normally under non-peak conditions, although that “weakness” is small on an annualized basis
- One year after reaching a record high, however, the market index is roughly the same percentage higher (7.4%) following a record high as it would have been one year later after any typical day (7.6%)
The Bottom Line
We believe this data shows us four things:
- Markets are relatively rational. A record high is only a record relative to where the market has previously been, not a predictor of where the market is headed.
- In competitive markets, all that matters to the rational investor is what is to come. Markets are, simply put, always forward-looking.
- Overall, there should be no lasting effect resulting from reaching an all-time-high. There is no “over-valuation.”
- Managers who pull back, increase cash, and look to time the market may, in the long run, miss out on the opportunities and growth that markets can provide.
This is why we don’t advocate panicking or trying to time markets, but instead focus on the potential power of markets to reward patient, long-term investors.