Equity returns in the last years of a bull market have historically been very strong, making it very painful to sell too early.
Bears have to be incredibly patient as many of the market’s major warning signs will flash red for months or even years before things turn. The cyclically-adjusted price-earnings (CAPE) ratio is at levels seen prior only to history’s great stock market crashes.
But while the CAPE ratio seems to be at a very worrisome level, it is an entirely different thing to conclude that it’s saying to sell. In fact, few experts warn against abandoning the stock market while CAPE is at elevated levels.
Markets could go up 50% from here.
The end is the worst time to be out of the market
While it may be tempting to predict the market’s peak, almost every interpretation of the historical data shows that this is a reliable way to miss out on gains or even lose money.
The average return in just the six months before past market peaks was a whopping 16%. Over the 12 months and 24 months before peaks, average returns were 25% and 58%, respectively.
In other words, if you had sold too early, you would’ve missed out on above-average returns.
The end of the cycle is often the best. Think 1999 or 2006-07. In a low-return world, investors cannot afford to miss it.
Experience has taught us not to miss the end of an expansive period.
Don’t trade in and out of the market
Let’s add some psychology to this discussion. During the period when you see above average returns, you’ll probably see a lot of above average single-day moves to the upside and to the downside. And with these moves, you might find yourself tempted to chase gains or sell in a panic. Unfortunately, this is a recipe for underperformance.
This strategy underperforms the market on a cumulative basis, every year has given the best days which typically follow the worst days.
Investors often think they should move in and out of financial markets, trying to time the buying/selling of stocks based on a series of events or increasing/decreasing their exposure depending on expectations for interest rates. History shows the value of staying invested in market for the income generated regardless of rates and proves the rewards of staying invested in stocks despite periodic market declines.
The market continues to break records. Recently Nifty50 closed at an all-time high despite stretched valuations and global uncertainty.
There is a constant theme in the financial media that this Bull Market is about to end any day now. I believe it still has a long way to go. It’s not going to continue straight up and we’ll experience plenty of corrections along the way. Ultimately, it will end with a ‘blow off’ move to the upside where everyone just throws in the towel. I don’t know if this will happen three months or three years from now, but I am leaning towards the latter because it will take a long time for investors to change their mentality.
The best gains to be had in the market are near the end.
The ability of the market to hurt eager bears some more is probably not exhausted. I still believe that, with the help of the central bank, the market will rally once again to become a fully-fledged bubble before it breaks.(Though the break will look more like a whimper than a bang).
To be clear, we’re not suggesting that the top is near and we’re certainly not suggesting now’s a great time to pour money into stocks. Rather, if there is a lesson to be learned it’s that the stock market is best-suited for investors with long-time horizons. Long-time horizons enable investors to wait out the downturns while reaping in the upturns. Indeed, the most important lesson which we’ve learnt from the past year of violent market swings is that the best strategy is to just stay invested.