The stock market’s recent rise to new record levels is impressive, particularly in light of economic conditions. Why is the market achieving new highs? We suspect, as a discounting mechanism, that the market continues to foresee healthy corporate earnings and cash flow and continued subdued inflation, and is therefore feeling a little more “confident” about the future.
Also, because of the slow growth economy, the market remains optimistic that excess monetary reserves being pumped by the Fed will continue to find their way into the stock market.
What is interesting about the new highs we’ve been reaching of late is how quiet our phones have been. It’s a very different mood now than was experienced in 2008 and 2009, when the markets were plunging. Back then, most every advisor was getting calls daily from distressed clients worried sick about their money. What drives this behavior? Predictable human psychology: greed and fear. People make irrational decisions when these emotions take over, like selling out at the bottom in a panic, or getting in at the top. People also tend to extrapolate the recent past into the future: if it’s really bad now, it can only get worse tomorrow, and vice versa. It is also normal human psychology to fear loss more than cheering gain. But history shows that 75 percent of the time, the market is rising and, over the long-term, has always gone up.
So what is the point of this for financial planning? One, avoid emotionally based decisions, which can wreck a financial plan; and two, avoid trying to time the market. In his most recent letter to shareholders, Warren Buffett put it in his inimitable way with regard to investing. He stated that “the basic [long-term investment] game is so favorable ... it’s a terrible mistake to try to dance in and out of [the market] based upon the turn of tarot cards, the predictions of ‘experts,’ or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.” While there may be times where it is prudent to reduce exposure to the stock market, over the long term, as Buffett points out, the odds are stacked in the favor of long-term investing.
Bob Toomey is Vice President, Research, for S.R. Schill & Associates, a registered investment advisor located on Mercer Island.