Fri, APR 4th, 2014
Fear of investing at market peaks is understandable. As Diane Lob and Ding Lui over at Alliance Bernstein observe: In the short-term, there’s always the risk that other investors will decide to take gains, or that economic, geopolitical or company-specific news will result in a market pullback. But for longer-term investors, market level really has no predictive power. Market valuation — not market level — is what historically has mattered to future returns.
The first chart below demonstrates, per Alliance Bernstein research (using data from FactSet and S&P), that the stock market is at or close to (within 5%) of its prior high nearly half of the time. There’s a simple reason for this, the stock market rises over time, along with the economy and corporate earnings. As a result, the market typically has regained its prior peak level fairly quickly after dropping. Then, it resumes its upward march, the analysts conclude. The second chart illustrates that valuation, not the nominal price of the index, is best suited for forecasting future returns.
To reiterate, long-run history tell us the majority of the time stocks are at or near record highs [Display 1]. As a result, if you used market level as a gauge you’d be out of the market more than you’d be in (or at the very least you wouldn’t be adding money to stocks very often, which is bad form in reaching long-run retirement goals). Indeed, valuation is a superior tool in forecasting future returns [Display 2]. And at present I believe that valuations are reasonable – particularly in the context of low rates, inflation and a durable economic recovery (with a still-accommodative Federal Reserve).
Jason L. Ware, MBA
Market Strategist, Chief Analyst
Albion Financial Group
(801) 487-3700; (877) 487-6200