Why a Stock Peak isn’t a Cliff

It is a widespread belief that stocks are considered overvalued when reaching all-time highs. Conventional wisdom advises buying equities when their prices are low and selling when they are high. While this sounds straightforward, it is often challenging in practice since equities tend to be rarely at their lowest points. So, should one hold onto cash until stock prices decline? It might be unexpected to discover that it doesn’t really make a difference whether you invest when the market is at an all-time high or when the market is at any level.

In the analysis of monthly closing levels for the S&P 500 Index from 1926 to 2022, 30% of these monthly closings represented new highs. When looking at the one-, three-, and five-year periods after the market was at all-time highs, we find that the performance numbers are almost identical when compared to the market closing at any level. This dispels the notion that one should refrain from investing when markets reach highs.

Financial journalists enjoy heightening investors’ anxiety about record highs by implying that what goes up must come down. However, equities are not heavy objects lifted by effort. They represent ongoing claims on companies’ earnings and dividends. If equities carry a positive expected return, achieving record highs regularly is precisely the outcome we should anticipate. People are prone to believe in the inevitability of a fall after a rise, enticing us to tinker with our investment portfolios. However, the data indicates that such signals are mere figments of our imagination, and our attempts to enhance results are just as likely to incur penalties.

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