Throwback to High-Waters

Story Highlights:

• More than a few folks want to know just how long it'll take the market to flood back to previous highs.
• A better question is which asset class has the edge looking forward—stocks will likely beat the alternatives.
• Long-term stock averages include both bull and bear markets. Bull market average returns are actually much higher than most would suspect.

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Geeky be damned, investors can't wait to break out their high-waters these days. (You know, those pants that fall ankle high, heroically defying flash floods.) More than a few folks want to know just how long it'll take the market to flood back to its previous high-water mark.

But that's the wrong question to ask. A better question is: What asset class has the edge looking forward? For most investors with a long time horizon, the answer is stocks. Cash pays almost nothing these days. And interest rates are likely to rise from here (although in all likelihood, not substantially any time soon), which will weigh on longer-term fixed income returns. Even subpar stock returns in the coming years seem likely to outperform alternatives.

We don't want to encourage anyone to focus on a high-water mark because it can lead to investing errors. After all, if you're a long-term investor, you're not investing peak-to-peak, but rather to improve the odds of reaching your long-term goals. But for those who simply can't tear their eyes away from that high-water mark, stock prices might be lapping it sooner than they think. The S&P 500 is about 40% below its 2007 high, so it'll take a 67% rally from here to justify rolled pant cuffs.

Everyone knows the market averages about 10% a year (give or take a bit, depending on when and how you measure). Averaging 10% a year, prices would break even in roughly 5 ½ years. That may seem like a long time, particularly since prices fell so fast on the way down. But a straight long-term average can be deceptive—average returns include both bull and bear markets. The bulls must make up for the bears, so they're above average—way above it. The average annualized bull market price return (not including dividends) is about 21%. Of course, it's higher with dividends, but reliable data doesn't go back far enough to deliver an accurate picture.

Once the bull market gets underway, and if returns are simply average for a bull—stocks would take a little over 2 ½ years to reach new highs. Less than half the time predicted using the more commonly quoted average growth figure of 10%. And that's if returns are merely average. We have to consider the other side of the coin too—the fall was abnormally steep and fast, so the subsequent recovery could be similarly sharp and swift.

No one can know what the future holds with certainty. But fashion's cyclical, just like markets. A throwback to high-waters could sweep stocks sooner than deceptive long-term averages would have you think.