Put on your party hats and get ready to celebrate, as tomorrow marks the second anniversary of the stock market surge that followed the financial crisis of 2008.
This surge has been remarkable. Since the low point on March 9, 2009, when the S&P 500 index closed at 676, the index has soared nearly 95 percent. On that day, it was down 57 percent from its peak of 1,565 recorded in October 2007. Remarkably, this increase is the most pronounced since 1955.
Investors who entered the market on March 9, 2009, during what many considered a catastrophic time, have effectively doubled their investments. At that moment, however, few would have described those buying stocks as foolish. While many panicked and began selling out of fear after witnessing their 401(k) balances plummet, only the savvy and fearless chose to invest.
The timing of buying and selling in the market is crucial. Ideally, investors want to buy low and sell high; yet, many do the opposite—purchasing at a peak and selling at a trough.
Now, with prices having doubled, many new investors are jumping back into the market at what might be a precarious moment. Let’s delve deeper…
Two Distinct Perspectives
Mutual fund investors are often classified as “dumb money” by Wall Street. This designation stems from their tendency to sell when stocks have hit rock bottom and to buy when they have peaked. For instance, according to DOW Jones Newswires on March 2, long-term mutual funds saw an estimated influx of $7.91 billion in a week, with $2.5 billion directed specifically towards stock funds.
The stock market started this year on a positive trajectory, with the S&P 500 rising by 5.5 percent in January and February, marking the best beginning since 1998. However, the market has since hit a plateau this March.
That said, it could simply be a moment for consolidation before continuing its upward trend. Conversely, it could also signal the beginning of a downward slide.
Here at the Economic Prism, we have anticipated a market correction for quite some time, particularly since the rally began. While we don’t possess concrete evidence, our intuition suggests that a downturn may occur soon.
Recent headlines indicate economic improvement, with the addition of 220,000 jobs in February and a decrease in unemployment to 8.9 percent. However, it’s essential to differentiate between the economy and the stock market; a recovering economy does not automatically promise sustained growth in a market that may be riding high.
Evaluating Risk vs. Reward
What we mean to convey is that current stock valuations, reflected in price-to-earnings ratios, indicate that stocks may be overpriced. According to an Associated Press report from last Friday, “investors are paying 24 times inflation-adjusted earnings over the last decade,” while the historical average stands at 16.
Moreover, potential inflation and a looming government debt crisis could hinder economic growth in the future. Yet, stock market booms can endure far longer than logic would suggest, especially with the Federal Reserve’s support.
“Legendary investor Jeremy Grantham, chief investment strategist at GMO, is known for his timing,” noted the Associated Press. In a letter to investors in early March 2009, Grantham asserted that while it was challenging to declare the market as having hit bottom, the steep decline was reason enough to buy. He predicted that the combined efforts of the Fed and government spending would lead to a rally “far beyond what is justified by either long-term or short-term fundamentals.”
In retrospect, Grantham’s insights proved remarkably accurate. So, what’s his current perspective?
While Grantham continues to criticize the Fed’s stimulus measures, he refrains from declaring stocks as entering bubble territory—yet. Should the S&P 500, currently just above 1,300, reach 1,500 by October, he warns, “it will be a market looking for an excuse to drop. At that point, with any substantial negative news, it could descend sharply.”
If Grantham is correct—again—there’s a possibility for the S&P 500 to climb an additional 13 percent from its current position. We acknowledge that this is feasible. However, each investor must confront a critical question…
Is the risk worth the potential reward?
This decision ultimately rests with you.
Sincerely,
MN Gordon
for Economic Prism
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