Currently, the stock market is surging, with the S&P 500 hovering near its all-time high of 1,565 set on October 9, 2007. Should we celebrate this milestone?
That’s for you to determine. However, remember what followed that peak in October 2007? The stock market entered a downward spiral that lasted nearly 18 months.
By March 8, 2009, the S&P 500 hit a low of 676, reflecting a staggering loss of 56.8 percent. Since then, it has rebounded by over 120 percent. Some analysts suggest it will continue to rise.
Maybe it will. But if you believe in the classic investment strategy of buying low and selling high—rather than buying high and selling low—now may not be the best time to invest. Sure, you could buy high and hope to sell higher, but it’s akin to jaywalking across a busy freeway; the risk-reward ratio is generally unappealing.
Yet, despite the risks, people are flocking to invest in stocks at unprecedented rates…
“In the week ending January 16, U.S. investors funneled a net $3.8 billion into equity mutual funds,” reports The Globe and Mail. “This followed an inflow of $7.5 billion in the preceding week, alongside another $10.8 billion invested in exchange-traded funds.
“Putting it all together, these are the largest two-week stock inflows since April 2000, according to Lipper.”
The Unfortunate Trend of Buying High and Selling Low
Unfortunately for investors, April 2000 marked a dreadful period for stock purchases. The S&P 500 reached its peak on March 24, 2000, at 1,527, before plummeting by 49 percent to 776 by October 9, 2002.
Those who rushed into stocks during April 2000 watched their investments halve in value. This raises an important question:
Why do people eagerly buy stocks as they near record highs? The optimal time to invest is actually during bear market lows, when sentiment is typically bearish, and most investors are selling rather than buying.
Clearly, investment psychology contradicts our understanding of purchasing behavior in other contexts. While we readily identify discounts on jeans or electronics, when it comes to stocks, many fall into the trap of buying at inflated prices and selling when values decline. The allure of new highs can cloud judgment, leading to impulsive decisions driven by fear or greed. Conversely, market downturns often incite panic, prompting investors to exit their positions when they should be accumulating shares.
Of course, no one can predict the future accurately. Stocks might soar to unprecedented heights. Nonetheless, we remain cautious with our investments, especially in light of potential headwinds facing the economy…
When to Avoid Stock Purchases
It’s crucial to grasp the distinction between the stock market and the economy. For extended stretches, GDP can rise while stock prices decline, and vice versa. In some cases, the stock market can significantly outpace economic growth.
For instance, from 1964 to 1974, U.S. GDP climbed nearly 125 percent, yet during this period, the S&P 500 plummeted by about 25 percent. Conversely, from 1974 to 2000, GDP surged roughly 583 percent while the S&P 500 skyrocketed nearly 2,400 percent.
We’ll soon receive the Bureau of Economic Analysis’ annual GDP estimate for 2012, likely showing growth between 2 and 3 percent. Nevertheless, over the same time frame, the S&P 500 increased by 11.6 percent—around 400 to 500 percent quicker than the economy.
The takeaway is that significant gaps can exist between the stock market and economic performance. A thriving economy generally benefits the stock market and a declining economy harms it, but they do not always move in lockstep. Eventually, however, they tend to align—even amid the Federal Reserve’s attempt to expand the monetary base by $1 trillion annually.
Currently, the S&P 500 is rapidly nearing its all-time high, while investors are pouring money into stocks at unprecedented levels. These indicators suggest, at the very least, that a market pullback may be imminent. Moreover, at some point, all these buyers will need to regroup, which will likely necessitate price adjustments for shares to settle.
In conclusion, while there are optimal moments for buying stocks, this is not one of them. Additionally, don’t underestimate the impact of increased payroll taxes, which will collectively reduce household incomes by approximately $125 billion in 2013, leading to a decline in consumer spending by the same amount. With slow growth, weak employment, and rising food prices on the horizon, the economic outlook for 2013 appears challenging.
The stock market will eventually respond to these realities, though many investors may not recognize the signs until it’s too late. This often results in selling at the lowest point—just when they should be preparing to buy.
Sincerely,
MN Gordon
for Economic Prism