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The Truth About Stock Market Highs and Lows

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we were all going direct to Heaven, we were all going direct the other way.” - Charles Dickens

In the financial community, for every cogent argument there is usually an equally compelling view to the contrary. As often as one observer opines that we are at a market peak there is another who beats on the drum of unusual opportunities.

Market Highs and Lows

Is the market too high? Too low? Who is to say? Yet over time, the Dow Jones Industrial Average has climbed from 100 to 1,000 and then on to 10,000 and higher. For those who lament that stocks are too high, one needs only to point out where the averages were when that person was born or had some other life event. For those who fret about periodic down markets, it seems worth considering that there is a far greater likelihood that the averages will gain 100% than they will drop to zero. Barring Armageddon, in which case it will not matter anyway, the long-term path of least resistance is up. (For related reading, see: Does the S&P Follow the Consumer Confidence Index?)

Reacting to the Market

Even so, investors tend to be counterintuitive. Consider the lowly can of tuna fish, which may be selling in the local market for $1.50 each. Should the price of a can of tuna rise to $5, there would be few buyers. If, on the other hand, tuna plunges to 50 cents a can, demand would go through the roof. Yet with investors, behavior patterns are the exact opposite. The higher stocks climb, the more appeal they seem to have. When prices plunge and everything’s on sale, nobody is interested in buying.

Some of the greatest Wall Street sales of all time took place during the early 1930s, late 1974, early 2002, and March 2009. As extraordinary as the opportunities were at those times, few investors were sufficiently rational and insufficiently emotional to take advantage. The tiny minority with the fortitude to take action, however, were extremely well-rewarded. Why the reluctance to climb aboard? Simply because the watchword of those difficult times was fear, the fear that this time around would see the end of the real world as we had gotten used to knowing it.

Perhaps that was understandable, but when one recalls the great calamities of our time, including two world wars, the Great Depression, the attacks of September 11, and presidential assassinations and realizes that the investment world has survived and prospered in spite of it all, the optimistic view emerges as the only viable option. The market is far more likely to double than plunge into the abyss.

What takes place in the short term is unknowable. Efforts to discern otherwise are nothing more than wasted time. Still, investors have a special fascination with those who would have them believe in their abilities to foretell the fluctuations of the immediate future. If they should happen to offer the fountain of youth as a bonus for those foolish enough to buy into their pronouncements, so much the better. (For related reading, see: CNBC: Financial News, or Just Entertainment?)

Financial Weather vs. Climate

The behavior of the investment markets bears a striking resemblance to the difference between the weather and the climate. Weather is a short-term phenomenon; climate is what prevails over longer periods of time. When folks consider places to live, they think about the climate. Average temperatures and rainfall are usually predictable with a high degree of accuracy from year to year. But, if one tried to predict the weather for even a few days ahead, the odds of getting it right would deteriorate badly. The same is true of investments, especially stocks. If corporate fortunes improve over time, stock prices will move higher. They rarely move in tandem, but there’s usually a correlation when one takes the longer view.

What takes place during interim periods is a completely different story. At those times, external factors play a more significant role, not infrequently obliterating the influence of internal factors. Take, for example, the impact of the regular meetings of the Federal Reserve Board’s Open Market Committee. These are the meetings at which the Fed’s governors assess the prognosis for the economy and decide on interest rates. Of all the external factors that play upon the market, this is one of the most influential. Indeed, the market response directly following a Fed announcement may be dramatic, though it frequently turns out to be unrelated to what may follow over the next few days. If interest rates move higher or lower or when the Fed changes the wording in the commentary that accompanies its actions, that alone will change the tide, if only for a short time. Here again, the weather is the driving force, albeit temporarily.

Normal or Fair Market Value

Along with the thought of peaks and valleys is the concept of normal or fair market value. Many Wall Street seers have become infatuated with the concept that there is a way to come up with a defensible number for near-term market ranges. Indeed, every so often key business publications ask the gurus where the market will be in six or 12 months. Most are only too happy to throw their darts. The fallacy is that more often than not the market will sell above or below what might otherwise be considered a normal level. What’s even more fascinating is when any of the predictions ends up being close to the actual result and that predictor receives accolades for his or her vision. That’s silliness carried to an extreme. The reality in these cases is that it was coincidence. Nothing more. (For related reading, see: Can Tweets and Facebook Posts Predict Stock Behavior?)

Market returns over the many decades when records have been kept suggest patterns that make some sense. Strong periods are followed by weak periods and vice versa. The recent experience of the 1980s and 1990s bears testimony to this kind of occurrence. Returns during the last score of 20th century years were well above the prior mean return, which approximated 10% annually. So when the bottom line for the most recent decade ended up in the red it was further evidence of the balance that plays out over extended periods.

The fact that the numbers for such a span are poor does not preclude the possibility of good results from sectors and companies within those sectors that have prospered. Similarly, even in boom times there are those that disappoint. To be positioned for the more favorable opportunities, the sensible investor needs to diversify properly, by sector, by industry, by country and by asset class. Doing so is akin to the realization that by weaving together a number of threads, each of which may be weak, one ends up with a fabric that is strong.

Yesterday is not ours to recover, but tomorrow is ours to win or lose. - Lyndon B. Johnson 

(For more from this author, see: A Look Beyond the Stock Market Reactions to Trump.)