On Friday, May 17, the Dow Jones Industrial Average closed slightly above the 40,000 level for the first time ever. This no doubt generated mixed feelings among investors. Many were exuberant this huge milestone had been reached. But certainly, some investors are apprehensive about the runup in values and perhaps expecting a market correction at any time.
Given the volatility of the stock market, its logical to assume that a new high will facilitate a correction. After all, what goes up must come down, right? Well, not necessarily. Researchers at mutual fund company Dimensional have looked at this very issue. Data on stock market pricing in the U.S. goes back as far as 1926. Looking back at over 1,000 monthly closing prices, the S&P 500 hit new highs in roughly 30 percent of those months. After hitting a new high, researchers looked at returns one year later. 81 percent of the time the S&P was at an even higher level. After a 5-year period of hitting a new high, the S&P was higher 86 percent of the time!
“Well,” you might say, “this time its different. The Dow just hit 40,000! But it was also “different” when the Dow hit 10,000 in year 2000, and then 20,000 in 2017, and 30,000 in 2020. And now here we are at 40,000.
Interestingly, national surveys of consumer attitudes report a fairly high level of dissatisfaction with the economy. I think that’s partly due to what I call the peanut butter problem. Suppose a few years back, a jar of peanut butter was $5 and now it’s $8. We now hear inflation has slowed significantly. But the peanut butter is still priced at $8. Lower inflation just means future price increases will slow down. It doesn’t mean that we’re going to see $5 peanut butter again!
Consumer dissatisfaction is also fueled by the media. Depending on which news channel you watch, our economy is somewhere between “rapidly going down the tubes” or “the envy of the rest of the world.” I generally look at three measures to determine the condition of an economy: GDP growth rate, unemployment rate, and inflation rate. The actual numbers say: our economy is growing (as measured by real GDP); anybody that wants a job can get a job (as measured by unemployment rate); and inflation is near long term averages though a little higher than desired. So choose what you want to believe. I’d classify the current conditions as a Goldilocks economy: not too hot, not too cold, just about right.
You may be thinking that we’re due for a correction. And you could be right. But the historical data doesn’t back it up. With respect to your investments, be on guard against the opposing forces of fear and greed. Fear says the market will fall and I need to get out before it does. Greed says it will keep going and I should invest even more in stocks. A better plan: Determine your acceptable level of stock market exposure and stick with it through thick and thin.
