Common Sense: History Suggests Stocks May Have Farther to Go

With both the Dow Jones industrial average and the Standard Poor’s 500-stock index hitting new highs this week, and the S. P. 500 having already gained 10 percent in the first quarter, a growing chorus of analysts and financial advisers are warning investors that it is too late to join the rally.

Their logic seems unassailable: if ideally the goal of investing is to buy low and sell high, stock investors would indisputably be buying high right now. That the market would continue at anywhere near its first-quarter pace — an annualized return of 40 percent — stretches credulity. And by historical norms, this bull market, which began in March 2009, is aging.

Of course, this is what experts almost always say when stocks rise to new highs. So I wondered, what would have happened to investors who bought stocks in the past only after stock indexes hit new highs?

To find out, I used the S. P. 500 index, and looked for those points where the index hit a new high at least one year after its previous high. (These points should not be confused with market peaks, which can be identified only in hindsight.) I used a one-year intervening decline because new highs get attention only when a substantial period of time has elapsed since the previous one.

By my count, there have been eight such new highs since the S. P. assumed its current form in 1957. I also looked at the high reached by the S. P.’s predecessor in 1954.

If investors had ignored the adage that the easy money had already been made and bought an index fund at those points, then held the investment for five and 10 years, how would they have fared?

In all but one instance — if investors had bought in October 2007 — they would have realized positive returns, not adjusted for inflation. Even in that case, when the S. P. 500 surpassed the previous high set in 2000, the five-year loss was modest. Of course, it is too soon to know what the 10-year result will be, but with the market’s recent new highs, the index has recouped all its losses.

In several cases over those years, the gains were spectacular, ranging from over 100 percent to 200 percent and more. The best returns would have been realized by investors who bought in mid-1989, when the S. P. 500 surpassed the high previously set in October 1987, before the crash that year. By 1999, investors had nearly quadrupled their money in one of the market’s greatest bull runs.

(Of course, they were headed for a crash in 2000. Even though the market reached a peak that year, by my definition there was no new milestone high because the index had not traded below its October 1987 high for a year or more.)

It seems that buying high — or at least at new highs — may not be such a bad strategy after all.

Several experts I consulted this week suggested the result may not be as surprising as it seems.

Richard Sylla, a professor of the history of financial institutions and markets at New York University, pointed out that anyone who bought stocks early in the great bull markets beginning in the mid-1950s and in 1982 experienced outsize returns, even if they bought at new market highs. By contrast, if they bought at new highs reached in mid-1967 or 1972, returns were tepid, even negative when adjusted for inflation.

“The long periods between new highs — 1929 to 1954, 1968 to 1982, and 2000 to 2007 — were periods marked by both bad economic policies and wars,” Professor Sylla said. “The periods of steady advance — 1954 to 1968 and 1982 to 2000 — featured better economic policies and minor wars. Right now, it seems to me that economic policies are improving, as is the economy as we put the financial crisis behind us, and we are getting out of wars instead of into them, knock on wood. That could indicate that we are in the early stages of a period that might resemble 1954 to 1968 or 1982 to 2000. So the recent new highs could well be a signal that it’s a good time to invest in equities.”

Jeremy J. Siegel, a finance professor at the Wharton School of the University of Pennsylvania and author of the classic “Stocks for the Long Run,” said he agreed that “the data doesn’t bear out that just because the market has hit a new all-time high, it’s too late to buy stocks.”

Article source: http://www.nytimes.com/2013/04/06/business/history-suggests-stocks-may-have-farther-to-go.html?partner=rss&emc=rss