Must what goes up come back down?
Updated: Jan 18, 2022
The stock market has always had peaks and troughs. It also is often hitting new highs. Figure 1. below plots the changing value of a dollar put into the MSCI world index (net dividends) from 1970-2020. Notice what a wild ride it would have been. In the 1970s, we see the Arab oil embargo quadrupling oil prices and the S&P 500 dropping 43%. We see inflation hit 13.5% in the 1980s. The 2000s brought a Dotcom crash, the 9/11 terrorist attacks, and then in 2007, we had the financial crisis that dropped the S&P by 46%. Despite the volatile ride, if $1 had been invested in the MSCI World index in 1970, by 2020 is would be worth $80. (see note 1 below.)
Figure 1. Depicts $1 invested in the MSCI World Index (Net Dividends) from 1970-2020.
But with many market indexes continuing to hit new highs, it’s only fair to ask, “Does this mean the coming years are or more likely to produce lower than average returns?”
The recent report Why a Stock Peak Isn’t a Cliff looks at the above question. It explains that, while many investors may think a market high signals that stocks are overvalued or have reached a ceiling, S&P 500 Index Returns from 1926–2020 don’t necessarily support that hypothesis. Instead, during that period, one, three, and five years after a new month-end market high is similar to the average returns over any one-, three-, or five-year period. The report also found:
- In looking at all monthly closing levels between 1926 and 2020 for the S&P 500 Index, 30% of the monthly observations were new highs.
- After those highs, the average annualized compound returns ranged from nearly 14% one year later to just under 10% five years later. Those results were close to average returns over any given period of the same length.
Figure 2 below depicts these findings.
The report sums up the conclusions as follows:
“Reaching a new high doesn’t mean the market will retreat. Stocks are priced to deliver a positive expected return for investors, so reaching record highs regularly is the outcome one would expect.”
I’ll add that we know the market will retreat; we just don’t know when and how much or for how long. What we know is that disciplined investors look towards the long-term growth potential in our capital market.
I'm happy to talk this subject over with you on a complimentary call. As a fee-only fiduciary advisor, I never receive commissions and therefore am unbiased on this topic.
Disclaimer: Past performance is no guarantee of future results. Any indices referenced for comparison are unmanaged and cannot be invested into directly. Investments in securities involve the risk of loss. Nothing in this blog should be considered financial advice or recommendations. Your questions are unique to you and your own personal financial circumstances. You should consult with a financial professional before making a financial decision. See full blog disclaimer.