Stock Prices are High - What Does that Mean for Future Returns?
Almost all investors have thought about this question at some point in their investing lives. Many investors get stuck in neutral waiting for a downturn to try and buy on the “cheap”. Is this worth it? Or do high prices tend to indicate higher prices are coming? Let’s explore.
The two charts below show the 1, 3 and 5-year annualized returns for the S & P 500 after new market highs or after a decline of 10%, usually labeled a correction. Who doesn’t like a sale? Well, not so fast-that might be fine at the department store, but maybe not in your stock portfolio.
In US dollars. Past performance is no guarantee of future results. Declines are defined as months ending with the market below the previous market high by at least 10%. Annualized compound returns are computed for the relevant time periods after each decline observed and averaged across all declines for the cutoff. There were 1,115 observation months in the sample. January 1990–Present: S&P 500 Total Returns Index. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. January 1926-December 1989; S&P 500 Total Return Index, Stocks, Bonds, Bills and Inflation Yearbook™, Ibbotson Associates, Chicago. For illustrative purposes only. Index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the management of an actual portfolio. There is always a risk that an investor may lose money.
Returns one year after a new high have averaged almost 3% more than after a 10% correction. But, for the 3 and 5-year periods, the results are almost identical. If you’re in the accumulation period of your life, you should likely ignore current prices, as you are going to be buying constantly over a long period of time, and it will likely average out in your favor.
If you’re trying to time the market, give it up. No one has ever had any success in market timing over any extended period of time. Keep a balanced portfolio and rebalance it periodically. That way you’ll always be buying something on sale.