The S&P 500 and Dow both reached new all-time highs last week. Year-to-date, the stock market has continued to grind higher despite short-term worries around the pandemic, a retail trading frenzy, the Fed, inflation, tech stocks, the Suez Canal, and more. Even as we write this, there are new questions around forced block trades from a failed hedge fund and the potential ripples across the market. The bottom line?
Keep your eye on the horizon — not on day-to-day headlines
It may surprise some investors to learn that this is the 35th time the market has achieved a record level since the recovery began just one year ago. That may seem unbelievable except that, by definition, the stock market often spends most of its time at or near all-time highs as it rises during bull markets.
Chart: The S&P 500 has hit many new record highs since 2013
2021 market fluctuations are smaller than you may think
Despite bouts of market turbulence this year, the biggest decline in the S&P 500 has only been 4%. This may feel unusually small to some investors given how large the move in interest rates and certain sectors, such as tech, have been. It’s important to remember that the annual decline at some point each year tends to be closer to 15% on average, before recovering and ending on a positive note.
This is not to say that the stock market will rise indefinitely or in a straight line — it surely will not. Instead, it’s that there is often a gap between what we believe may matter and what actually does. It is not the fact that the market reaches all-time highs that causes it to pull back. What matters more than what stocks have done recently are the underlying trends that affect profits, valuations, and long-run investor expectations.
Investors should carefully balance two considerations
- The economy continues to recover, which is driving markets higher. It likely makes sense to stay invested as the new business cycle evolves and to stick to long-term asset allocations. There will no doubt be more hiccups around inflation, monetary policy, the US dollar, and more as this develops. However, history has shown that stocks tend to rise over long periods of time as the world improves.
- Investors would generally do well to remain disciplined and avoid complacency, especially while valuation levels are elevated. At the moment, the broad market trades at a price multiple of 22 times next-twelve-month earnings – near its historic peak of 24.5x during the dot-com bubble. Of course, this is due to the collapse in earnings during the pandemic lockdowns. If earnings can fully recover and achieve new levels by the end of 2021, as many expect, this ratio could slowly fall to more attractive levels.
Thus, investors face a balancing act between taking advantage of the business cycle and staying disciplined. While this is a difficult balance to strike amid constant distractions, history has shown that those who are able to do so have a better chance at achieving their financial goals.
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