January 30th, 2017 | by Andrew Tanzer, CFA, "The Global Equation"
Dow Hits 20,000. Now What? (Part One)
- With several US market indices at historical peaks, some investors are wondering if it’s time to sell—or buy.
- Gerstein Fisher research found little evidence that new market highs are good indicators that it’s time to cash out.
- 2016 was a year that proved many market and political prognosticators wrong, from Brexit to the US Presidential election.
- Patient investors who rode out some of last year’s turbulence and predictions of economic doom were rewarded as the S&P 500 Index closed out the year with a 12% gain (the eighth consecutive year of positive returns).
In recent days, the Dow Jones Industrial Average blew through the symbolic 20,000 mark and the S&P 500 Index and NASDAQ have reached historically high levels. Investors have asked us whether these new peaks are a signal to buy or to sell. While we neither advocate nor practice market timing, we addressed this question in our recent Winter 2017 Market Perspective letter to investors from our head of research, Gregg Fisher.
We studied the question of whether, when markets hit new highs (as several US indices have done in January 2017), it’s a good time for investors to cash out. Our conclusion: new index highs have historically not been useful predictors of future returns. From 1926 through the end of 2016, the proportion of annual returns that have been positive following a new monthly high is similar to the proportion of annual returns that have been positive after any index level. In fact, during this time frame of nearly a century, almost one-third of monthly observations following a peak were new closing highs for the index.
The Trump Era
Naturally, we are being asked how investors should approach the uncertainty created by an unconventional President, a new Congress, and their ambitious but contentious 2017 policy agenda. For our take on new presidents and the danger of political biases to investors’ health, I suggest you read (or re-read) our post from shortly before the November election: “Hillary or Donald: Who Would be Better for Your Portfolio?”
Particularly because the current political and policy picture is so cloudy, be wary of the political, economic and investment readers of crystal balls who are coming out of the woodwork. As Gregg writes in his letter, “expert” predictions of the future are usually no better than guesses—occasionally they are right, more often they are wrong—investors need to stay focused on long-term goals and abstain from reacting emotionally to politics, speculation, and the confident utterances of self-styled pundits. Investment sage Warren Buffett once commented: “Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.”
Obviously, 2016 was a year in which forecasters, neither political (re: “Brexit,” Trump) nor financial-market ones, exactly covered themselves in glory. In the opening weeks of 2016, you’ll recall that US stocks slumped 10%, oil prices fell below $30 a barrel, and bond prices surged. Many forecasters predicted doom and even a US recession. Almost before the ink was dry on these predictions, equity markets rebounded, oil prices surged to more than $50 by year’s end, and the US economy picked up steam to grow about 2.5% (annualized) in the second half of 2016, compared to just 1% in the first half. Many pundits projected an equity market collapse if Trump was elected. When it happened, markets reacted to his surprise victory with a swift re-pricing: major US stock indices surged to new highs in a matter of weeks, and bond yields jumped on the wager that Trump’s economic policies would stimulate economic growth and inflation.
Despite the (domestic and global) pessimism and ups and downs of 2016, the year ended quite nicely for disciplined investors. Far from surprising us, this result confirms what we’ve observed over the years through research and experience, which is that staying invested and avoiding making portfolio changes based on short-term predictions greatly increases the likelihood of long-term investing success. Despite all the uncertainty of 2016, the S&P 500 Index closed out the year with a 12% gain (the eighth consecutive year of positive returns), foreign stocks rose 4.5% (MSCI All Country World Index ex-US), and most major asset classes performed well, illustrating just how difficult it is to try to outguess market prices. Once again, a simple strategy of embracing sensible asset allocation and broad diversification was less likely to frustrate investors than was fretting over portfolio changes in response to news events and revised market forecasts.
Exhibit 1 illustrates the dramatic turnaround of many asset classes in 2016. We will pick up on this theme in our next posting in this series, with particular focus on factor-based investing and international equity cycles.