On May 22, the Dow Jones Industrial Average, one of the oldest stock indices in the US (made up of 30 “blue chip” stocks), reached a new all-time high of 40,000.
Other more broadly-based indices such as the S&P 500 index (large-company stocks) and the Nasdaq Composite index (heavily weighted toward tech stocks) also attained fresh highs in mid-May.
The stock market can be viewed as a mirror of sentiment and as a measure of value, and new highs tend to be well received by investors. Strong demand for stocks has boosted prices and has created pleasing portfolio returns.
Regarding sentiment, most Wall Street prognosticators are bullish. In fact, the ranks of Negative Neds and Nellies recently faded from two to one.
The lead strategist at Morgan Stanley, well-known for his persistent bearish views, revised his 12-month stock market target sharply higher in May. Of seven leading investment banks, JP Morgan is the only firm anticipating a significant market decline by year end.
Even though the economic and market backdrop is constructive, a contrarian would suggest that stocks are climbing a wall of worry.
As we consider the situation at home and overseas, there’s plenty of cause for concern, including:
- the rising costs of goods and services have made everyday living ever more expensive for consumers
- a deeply polarized political environment in the US raises concerns about the possibility of civil disorder and the potential degradation of democracy
- persistent conflict abroad is affecting the lives of millions
Worried investors who are overly pessimistic about the economic, political, or social landscape might be tempted to say “enough is enough.” Acting on this conviction by selling a significant portion of stock holdings likely would provide an immediate sense of relief for those seeing the glass as half full.
But this type of action invites the “pain trade”, where financial markets punish investors for their decisions, typically in the form of substantial losses or a missed opportunity for upside.
The pain trade for worried investors who sell their stocks today would occur if the stock market rally of 2023-24 proves persistent.
Nicholas Colas of DataTrek Research provides the following pointers for avoiding the pain trade (via a recently published article in Barron’s):
- Don’t be irked by short-term losses; it’s better to endure a 20% to 30% dip, typical for bear markets, than to miss out on all of an investment’s future gains
- Trust in the prospects of large company US stocks, which consistently deliver for investors over the long term
The adage “it’s time in the market, not timing the market, that matters” might cause a wince or an eye-roll from experienced traders. But consider the chart below, courtesy of AMG, which tracks cumulative returns of US large company stocks.
The yellow dots denote twelve major market pullbacks, starting with the Great Depression in 1929. The dark green shaded areas show the stock market rallies.
Two key take-aways:
- rallies tend to run on for extended periods, while sell-offs are typically sharp (and painful) but far shorter in duration
- the peaks historically have risen far higher during rally periods than the troughs have fallen during sell offs
Perhaps the phrase “it’s time in the market that matters” might serve as a helpful reminder of the benefits of cultivating a patient approach to investing and embracing long-term thinking when it comes to your personal financial situation.
Summing it up, DataTrek’s Colas offers the following: “In the end, the worst pain trade is being underinvested.”
RK