New Highs... For Markets and Anxiety
By some measures, global political uncertainty is at an all-time high (e.g. www.policyuncertainty.com). While many are feeling unsettled with the direction of the U.S. under a new administration, things aren't exactly tranquil elsewhere in the world. Questions still surround the course of Brexit, concerns are climbing over a re-emergence of the Eurozone debt crisis, and potential government changes in Germany and France are creating unease. Interesting times indeed!
In the face of all this, we recently reached the well-publicized milestone of "Dow 20,000." What does all of this mean, and what should we do now? Should we cash out and wait on the sidelines?
Let's start with "Dow 20,000." There is a tendency to view new highs as a
bad sign, based on the old adage that what goes up must eventually come down. But new highs really don't tell us anything of value. Based on monthly data over the past 90 years, the market (S&P 500 Index) saw positive returns in 80% of the 12-month periods following a new index high point. That's slightly better than the performance after
any index level.
We shouldn't be too surprised by this. The market has an upward trend over time and we should expect more positive years than negative. We also shouldn't be surprised that 29% of monthly observations were new closing highs - that's something to be expected as the market grows. New highs simply don't give us any information about what will happen next - even the nice, round "historic" market highs.
What about all the uncertainty? Perhaps we've repeated the cliché' that "markets hate uncertainty" a time or two, but it's far too simplistic. Let's face it, do we actually know less about the future now, or are we simply more nervous about what we don't know? There was a fairly high level of certainty regarding a Clinton victory and a no vote on the Brexit referendum, but neither turned out as expected. Misplaced confidence is really no better than admitting we don't (and can't) know the future.
Two interesting facts on the political front:
* Investor anxiety over a Trump victory was followed by a 10% increase in stocks (nicknamed the "Trump trade"). This has been one of the larger (YUGE!) post-election rallies in history.
* A study by Ned Davis Research showed that a presidential approval rating between 35 and 50 percent was followed by one-year average stock returns of more than 12%, while approval ratings above 65% led to gains averaging just 1.4%.
It's hard to know exactly what to make of this information. Maybe we don't actually know what's good for us, or perhaps we are simply better off when optimism is in check. Or maybe factors like interest rates and monetary policy are more important than political policy, and the U.S. economy is more stable and resilient than we appreciate. Whatever the case, it turns out that fear and loathing are not a stumbling block for markets.
The best takeaway is probably to pay little attention to financial headlines, both good and bad. There is little actionable information to be had, and it's likely to cause needless stress and anxiety. For the most part, financial media is unnecessary noise that can be avoided. Steve Forbes, publisher of Forbes Magazine, was once quoted saying, "
You make more money selling advice than following it. It's one of the things we count on in the magazine business - along with the short memory of our readers."
So what should investors do? Focus on what you can control and quit worrying about the things you can't - stress is bad for your health.
The number one thing you can control is the amount of risk you take. If you are younger or have money you can afford to lose, you can take more risk. However, make sure you've prepared yourself mentally for when we have a downswing in the market. Many people run for the doors at that point - generally the worst possible time - and that is why they don't do well.
If you are retired or would be devastated by losing a large amount of money, do not put large amounts of money at risk in the stock market. If the market goes up tremendously you will have missed some gains, but when the markets correct as they always do, and especially if we have an extended bear market, you'll be thankful you controlled your risk.