Is it Time to be Fearful?

As investment (and behavioral) managers we often talk about not letting emotions dictate our clients’ investment decisions.  Emotions often lead investors to either chase returns or panic out of the markets at the wrong time.  Warren Buffet’s famous quote to “be greedy when others are fearful, and fearful when others are greedy” is a favorite, and actually implies investors may be better off doing the opposite of what their emotions are telling them to do.  Given that the S&P 500 has been flirting with all-time highs this year, is it time to “be fearful” and pull out of the markets?  All-time highs can be worrisome as stock market crashes most often start at an all-time high.

One thing to understand about markets is they are always cyclical. Sometimes those cycles turn quickly but, most of the time, markets overshoot to both the upside and the downside. In other words, when we do reach new all-time highs, we tend to continue to do so for quite some time.  Below is a chart showing all-time highs (in green) since the 1950s.
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As the chart shows, just because the market reaches a new all-time high does not mean that a subsequent crash is right around the corner.  In fact, there is a greater likelihood that we will continue the up-trend and endure more market tops, until we don’t.

Since 1950, there have been new all-time highs on 6.7% of all trading days. In the 1990s, it was more than 12% of all trading days.  From 2013-2019, it happened on 14% of all trading days. Despite two bear markets this decade, the S&P 500 has hit new all-time highs on 11% of all trading days in the 2020s.  While markets will eventually pull back, new highs are nothing to be afraid of.  In fact, new highs are a bullish signal most of the time.

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To drive this point home, look at the chart below from J.P. Morgan.
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The chart compares returns by investing on any given day compared to returns when investing on a day when the market hits an all-time high.  Surprisingly, returns are actually better for each time period when investing at a market high.

So while Warren’s advice about fear and greed is a classic quote about emotional investing, perhaps the best approach is not to be either greedy or fearful, but instead commit to an investment strategy that allows you to stay invested through both up and down markets.  

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