Stocks are flying. Routinely clocking new record highs in the US, which notched #109 of this bull market last Thursday. World stocks hit #65 the same day. Across the pond, the FTSE 100 is a whisper below its previous peak (January 25, 2000) and that lovely round number 7,000. Volatility is down, trading volumes are down, and 25 months (and three days) have passed since the last correction ended. Surely it all must mean something, pundits say! But what? And more importantly, what is a long-term investor to do?
The financial press was teeming with articles trying to answer that question on Monday. Some warned markets are ignoring risks, like an eventual fed funds rate hike, and investors should be more cautious. Some said a high-dividend strategy is best—a cushion in case stock prices fall.[i] Others said moving more to cash made most sense—because at some point the market will turn and cash will prove wise. A handful said it would be loony to take anything off the table right now, but for bizarre reasons.[ii] And some said staying in stocks makes sense only if earnings and revenues accelerate—just to prove the economy is indeed “warming up.” What do these tidbits of advice have in common? They’re all noise! If you have a lengthy time horizon and long-term objectives for your money, any investment decisions you make should be based on those factors. The market’s outlook over the next 12 to 18 months is a consideration as well, but not past performance (ahem, all-time highs) or potential near-term volatility.
Corrections, potential corrections, potential short-term reactions to monetary policy moves that may or may not happen at some unforeseeable point in the indeterminate future—none, in our view, are reasons to allow your portfolio positioning to deviate from your long-term goals. Nor is the fear that we could be near a peak just because of how far this bull market has come, or because earnings growth isn’t gangbusters, or because of any other arbitrary observation the punditry might trot out. Past performance never predicts the future, and it’s normal for earnings growth to slow, jump and slow again as bull markets age—that’s what happens when firms can no longer boost earnings through cost-cutting and year-over-year comparisons get harder to top.
There are times when it makes sense to temporarily change your portfolio’s tactical positioning away from whatever long-term mix of stocks, bonds, cash and other securities fits your long-term goals and objectives. But that time generally occurs when you have a strong belief a bear market is forming—typically defined as a stock market downturn of more than 20% over several months or more. “Stocks are high” isn’t a good reason to go bearish—no bear market in history has begun simply because some stock index reached a certain level. Bear markets usually begin when investors are too euphoric to notice deteriorating economic or political conditions, when some huge and largely unseen negative with the ability to whack a few trillion off the world’s economy or financial system materializes, or some combination of the two. Not the widely discussed risks we read about every day, like occasionally sluggish (or contracting) GDP, chaos in Iraq, bullets and tanks in Ukraine and legislation like FATCA or the Affordable Care Act. Rather, big ugly things no one talks about—like monetary policy errors few see, wacky regulations written by agencies with no public comment or legislative oversight or a steep rise in trade protectionism.
We see few traces of any similarly huge, surprising risks today. We see ghosts of possibilities—there always are—but nothing likely enough to come to fruition to spur investors to change tack. Over the foreseeable future—the next 12 to 18 months, a meltdown seems the least likely outcome.
Yes, at some point, a new bear will begin. And when that happens, investors with large cash positions will almost surely benefit. But that doesn’t mean squirreling away cash now as an insurance policy is wise. Missed returns—opportunity cost—are a heavy price to pay. All those articles suggesting cash is king simply because stocks look lofty miss this basic truth.[iii] The S&P 500 Total Return Index was at all-time high number 153 (of that bull) on August 25, 1987, the day before markets started pricing in a liquidity squeeze few investors noticed. It was at number 345 of the 1990s bull on March 24, 2000, the day before investors claiming clicks were the new cash missed the first puffs of air hissing out of the tech bubble. But it was only at number 46 on October 9, 2007, when markets got hip to the likelihood of fair-value accounting wiping trillions off bank balance sheets. 153, 345 and 46. See any patterns? Neither do we.
With no signs of investor euphoria and precious little likelihood of the bull market hitting the wall in the foreseeable future, now isn’t a time to materially deviate from your long-term asset allocation. Not build up a just-in-cash cushion. Not concentrate in something that seems hot. Not look for “safe” stocks or some gimmick promising capital preservation and growth.[iv] Just keep it boring and simple and enjoy more bull market ahead.[v]
[i] A bizarre thesis when you remember high-dividend stocks’ prices can and do fall, too, and their dividends can go at any time.
[ii] One pundit tried to argue all-time highs are just plain bullish because they, like, never occur during bear markets. Which seems like a) a great big load of duh and b) sort of weird when you remember that most bear markets in history began the day after an all-time high. But hey, what do we know.
[iii] They also inherently assume past price movement predicts future returns, but that’s a topic for another day. June 24, 2014, to be exact.
[v] We were tempted to add another point, but it seemed like a footnote. So here it is: Keeping a cash cushion just in case is a classic behavioral error. We say this because you might consider the opportunity cost and decide it’s worth it for the peace of mind. But will you still be able to keep that same mindset when we get to the actual peak? Or will you be feeling left out after months, a year or maybe even years of seeing everyone else ride the market ever higher and decide you want a slice of the action for yourself? Right before it turns?