Fisher Investments Editorial Staff
Behavioral Finance, Capitalism, Market Cycles, Media Hype/Myths

Indicator Acrophobia

By, 02/25/2011

Story Highlights:

  • With major indexes like the Dow hovering at 12,000 and the S&P trading around 1,300, many ask whether this marks a convenient exit point. We don't think so.
  • We can find no evidence ever in history that stocks have retreated after hitting a "nice round number."
  • To think stocks will never rise past a previous peak is to believe there is no further ingenuity that can add to global wealth ever again.

After a third consecutive down day on Thursday, it may not feel like it, but global stocks are up this year and up 92.71%* since the bear market low. With major indexes like the Dow hovering at 12,000 and the S&P trading around 1,300, many ask whether this marks a convenient exit point. We don't think so. We don't think this year is as stellar as 2009 or 2010, but we believe 2011 is all part of an ongoing bull market. 

More important, investors should utterly ignore "milestones" like index levels (and numbers of consecutive up or down days). They tell you nothing about what will happen next. As humans, our brains naturally seek patterns—to create order out of chaos. We focus on round numbers, previous high water marks, or what may just seem "too high" (e.g., stocks rising 92.71%*). And there are those patterns that simply defy logic—but any pattern lacking sound fundamental explanation should be regarded with equal skepticism.

Simply, stocks don't care about milestones or markers or humanity's emphasis of nice round numbers. We can find no evidence ever in history that stocks have retreated after hitting a "nice round number" just because said round number was attained. Stocks certainly aren't scared of high-water marks (though investors certainly can be). There is no fundamental reason preventing stocks from surpassing past peaks and then continuing higher. Were it not so, bull markets would never achieve new heights. Yet, forever, stocks can and do hit past high points and keep rising—adding ever more shareholder value in an agonizingly unpredictable pattern.

There are plenty of reasons stocks don't obey milestones. For one, human ingenuity. If stocks could never surpass a previous milestone, then shareholder value could only expand and increase inside some predetermined bandwidth, and capital markets would function as some sort of cosmic seesaw. We're not aware of capital markets behaving that way (but then again, for the life of us, we could not figure out the significance of number 23). Yet, think of all the trillions in shareholder value that have been added over the decades, thanks to robotics, cool new gadgets, lifesaving drugs, etc. To think stocks will never rise past a previous peak is to believe there is no further ingenuity that can add to global wealth ever again. That, or the indexes we use to measure stock performance are disastrously flawed. We don't want to live in a world where either is true.

Most investors understand that rationally, but it's hard to make our brains stop seeking patterns even where none exist—and that can cause costly errors like locked-in losses and needless transaction fees in addition to lost opportunity. All because of some round numbers. 

Will the S&P 500 live to hit 1400? Or 1500? Sure. We don't know when, but we can guarantee you that unless Standard and Poor's changes its methodology or stops publishing its very popular index, the S&P 500 can hit 5000 and beyond. And we assure you, that will be as meaningless as to what stocks do next at 1300, 1450, or 1517.

 

 *Bloomberg, Inc.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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