After Unexpected Gains, Should We Automatically Expect Heavy Losses?
Presented by Mark K. Lund, Financial Advisor
The market in the first quarter of 2024 defied the expectations of the leading indicators (and conventional wisdom) to continue its upward path.
Howard Silverblatt, writing for the S&P Dow Jones Indices report, put it aptly. “Neither inflation nor Fed rates nor interest costs nor gloom of consumer and government debt (nor government shutdowns—seems we have more than the saying has room for) stays these markets from their new closing highs . . .”1
The S&P 500 had six new closing highs in January, followed by eight more in February, and then eight more in March. This capped a five-month run where the index has gained a cumulative 25.29% and added $8.9 trillion to shareholders’ balances.2 However, as anyone who’s been in the market for a few years knows, things don’t go up forever. Some investors are surely thinking that the big gains of the past few quarters surely can’t last. Isn’t it inevitable that they will be balanced out by equally big losses? And if that’s the case, isn’t this a good time to take your gains and get out of stocks and into something else?
Surprisingly, the answer to both questions is no.
Of course, past market behavior is no guarantee of future results. But historically, getting out of the market right after a big gain has proved to be a big mistake.
Let’s look at a hypothetical example of really poor market timing.
Investing at the Worst Possible Time
The odds of being struck by lightning once in a year are less than one in a million.3 The odds of being struck more than once are infinitesimally small. And yet, according to the Guinness Book of World Records, one person has survived being struck by lightning seven times, Park Ranger Roy Sullivan.4
What would happen if you transferred Sullivan’s remarkably bad luck to timing the stock market? Of course, nobody would want to do this on purpose, but it serves to illustrate the very worst you could have done. Several years ago Ben Carlson, a wealth manager and financial writer, did an analysis of a hypothetical portfolio that did this very thing. Carlson posed the question, “What would happen to your returns if you invested only on the market’s peak days?”5
What he discovered runs contrary to conventional wisdom.
First, Carlson looked at the frequency of new all-time high days. He defined these as days when the S&P 500 reached a value that superseded its previous high. For example, he determined that from 1988 through 2020 there had been more than 600 all-time highs, about 7.3% of all trading days.
Next, he compared returns for buying the index over time versus buying only on the peak days.
The results are surprising. According to his calculations, a person who invested only on peak days would have had slightly better returns than a person who spread out their purchases over all days.
How is that possible?
“All-time highs tend to beget all-time highs,” Carlson explains, “simply because that’s the way the markets work in a raging bull.”
In other words, when the market is doing well, it tends to continue doing well. This doesn’t mean that corrections won’t come. But just because a new high has been reached doesn’t signal an automatic pullback. In fact, over the past century stocks have beat their 10% long-term average in 58 of those years. They fell (to any degree) just 26 times—less than half as often. So historically, you are more than twice as likely to enjoy above-average years than to encounter down years.6
Of course Carlson doesn’t recommend this as an investing strategy. First of all, there’s no way to predict when new peak days will occur. Rather, he points to it as a demonstration that investing at all-time highs doesn’t have to be a losing proposition.
The past performance of the market is no indicator of how it will perform in the future. And historically, there have been some long periods between all-time highs. But over the long-term, people who’ve stayed in the market have been rewarded.
Knowing this, a prudent investor will continue to take a broadly diversified approach with the close support of a trusted financial advisor and be ready to take in stride whatever comes next.
Sources:
1. https://www.spglobal.com/spdji/en/documents/commentary/market- attributes-us-equities-202402.pdf
2. https://www.spglobal.com/spdji/en/documents/commentary/market- attributes-us-equities-202403.pdf
3. https://www.cdc.gov/disasters/lightning/victimdata.html
4. https://en.wikipedia.org/wiki/Roy_Sullivan
5. https://awealthofcommonsense.com/2020/12/investing-in-stocks-at-all- time-highs/
6. https://nypost.com/2024/03/25/business/why-investors-are-grappling-with- a-fear-of-heights-in-2024-and-what-98-years-of-history-tells-us/
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