photo by Flickr user Pablo
After a slump in late 2018, the stock market has officially bounced back, at least for the time being. Investors should remain calm at this new peak, just as they should have during the declines late last year.
Last Friday, the S&P 500 reached its highest-ever closing value, beating the record set last September and marking a 25% rally from its Dec. 24 low point. The Nasdaq composite broke its previous record the same day. The former index is experiencing its best start to a year since 1987, and the latter its best since 1991. “It’s almost like the market is calling a mulligan on what transpired in the fourth quarter,” Michael Baele, a senior portfolio manager at U.S. Bank Private Wealth Management, told The Wall Street Journal.
Analysts have identified several factors driving this market rally. Optimism about the U.S. economy remains high, even though corporate earnings growth was expected to decline after last year’s surge following the tax reform package that passed in late 2017. Yet dozens of individual companies have recently reported better-than-expected profits, bolstering the overall economic outlook. The labor market remains tight and retail sales have stayed generally strong. The Federal Reserve has signaled a more modest pace for future interest rate hikes, which has helped calm some investors. And while trade tensions with China have not been resolved, they have largely taken a back seat in the news cycle during the first few months of the year.
It might seem odd to sound a note of warning in light of all this good news. But market cycles often play with investors’ emotions at both the bottom and the top of a cycle. Short-term movements – whether positive or negative – are fleeting by definition. It’s no smarter to pay too much attention when market sentiment is good than it is when it is worrisome.
While most observers interpret the current market as a recovery after a temporary dip, some analysts have been quick to say that investors are too complacent about the future of the stock market’s years-long climb. The truth is that, as always, no one can know for certain what the stock market will do next. That said, upward cycles never last indefinitely. We are still due for an economic recession in the (maybe near) future. While most economic data remains strong for now, that means surprises to the downside might be more likely than surprises to the upside.
On the other hand, it is possible a recession will not arrive for a while yet. The Fed seems less likely to overshoot and increase rates too high, too fast, which was a major concern only a few months ago. We may be in for a “soft landing” recession, in which the economy slowly cools down after years of growth. This means we may not have a crash or a crisis like the last two major recessions, which were predicated largely by the housing crisis and the dot-com bubble, respectively. It’s important for investors to keep in mind that not all future market declines will be the result of a crisis or crash like either of these. A more normal recession and market decline may result when the economy cools off naturally after years of growth.
None of this means that investors should make overly aggressive moves now, either buying because they think the market will continue gaining or selling because they are afraid it is due to crash. At Palisades Hudson we encourage our clients to stick to their long-term strategies unless anything major changes in their personal situations. This helps them to avoid the emotional temptations market news can create. A particular investor’s plan may involve some buying or selling in the current market, but such actions should be a function of the parameters that investor set in place earlier. For example, rebalancing your portfolio to keep its target asset allocation in line is a prudent strategy. Staying calm and rational in both good times and bad is the best way to avoid the pitfalls of herd mentality and other common investor mistakes.
No investment can appreciate, unchecked, forever. Stocks are inherently volatile, and investing always carries risk. Sometimes that means unexpected declines – and sometimes that can mean quick, unexpected gains. But normal market fluctuation alone is not a reason to change an otherwise appropriate long-term investment plan.
The thing about market cycles is that they never reach an end point. Cycles move through a pattern of peaks and troughs, and they always will. Disciplined investors know not to get caught up in either optimism or pessimism. Sticking to the long-term view will help you cut through the noise and avoid any unnecessary missteps at both the bottoms and tops of market swings.