Why a Stock Peak Isn't a Cliff
There’s often a little concern around sharp increases in market value, with investors worrying that this might, in turn, cause stocks to plummet.
Thankfully, this isn’t the case at all. Again, it’s a topic our friends at Dimensional have already covered in the below article, first published in December 2021.
Average returns are similar
Many investors may think a market high is a signal stocks are overvalued or have reached a ceiling. But they may be surprised to find out that the average returns for the S&P 500 Index one, three, and five years after a new market high are similar to the average returns for the index over any one-, three-, or five-year period.
In looking at all 1,000-plus monthly closing levels between 1926 and 2021 for the S&P 500 Index, 30% of the monthly observations were new market highs. After those highs, the average annualized compound returns ranged from over 14% one year later to more than 10% over the next five years. Those results were close to average returns over any given period of the same length. When viewed in terms of the index simply having risen or fallen, the S&P 500 was higher a year after notching a record 82% of the time, and 86% of the time after five years.
Exhibit 1
S&P 500 Index Returns
1926-2021
Past performance is not guarantee of future results. Performance may increase or decrease as a result of currency fluctuations.
History shows that reaching a new high doesn’t mean the market will then retreat. In fact, stocks are priced to deliver a positive expected return for investors every day, so reaching record highs with some regularity is exactly the outcome one would expect.