Riding the Highs and Lows
After a down year in share markets, investors might naturally hope for a rebound. Likewise, when markets hit record highs, as we have seen recently, investors may be gripped by a sense of vertigo. But the fact is that a new market high or low doesn’t tell us anything about what will happen in the coming year.
Let’s look at history to answer three questions on that score. First, just how common are new market highs? The short answer is very common. In fact, in the 528 months from the beginning of 1980 to January 2024, the S&P/ASX 200 Index posted new closing highs nearly 30% of the time!
This shouldn’t really be a surprise. Since markets generally tend to go up over time, new highs should be a relatively common occurrence. And think about it: If experiencing positive returns were a troubling development, what would be the point of investing at all?
The second question is what happens one year after a market either reaches a new high or experiences a downturn of 10% or more from its record peak. The exhibit below shows similar percentages for when the market is higher a year on from either an up market or down market. Additionally, the returns are not reliably different from each other.
Of course, this doesn’t mean that a record high necessarily points to new highs in the year ahead. It just means where the market has been in the past year tells us nothing about where the market is going in the short term. The temptation to react to market highs and lows can be strong, particularly with the benefit of hindsight. It can be helpful to remember that hindsight is 20/20, but foresight and what the market will do next isn’t.
But this leads us to our third question, which is what happens when an investor stays disciplined through all the unpredictable highs and lows a market registers over much longer periods? Here we can see that $10,000 invested in the S&P/ASX 200 in 1980 would be worth nearly a $1 million today.
There are three lessons here. First, since stocks have a positive expected return, reaching record highs with some frequency is the outcome you would expect. Second, a new high or low tells you nothing about what the market will do in the short term. Third, the key to successful investing is to cultivate a long-term perspective, one when you think in decades, not days.
Percent of Cases Where the S&P/ASX 200 Index (Total Return) is Higher 1-Year Later
This article originally appeared in Short N Sweet, a newsletter for Dimensional clients.
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