Fear of heights: Investing at all-time highs

Please note: This article is more technical in nature than our typical articles, and may require some background knowledge and experience in investing to understand the themes that we explore below. 

All data referenced in this article are sourced from Bloomberg unless otherwise stated, and is accurate at the time of publishing.

Key points

• All-time highs can feel like a bad time to invest, but historically they’ve frequently occurred. In fact, the S&P 500 has ended the month at a record high over a quarter of the time since 1950.
• Beware of the gambler’s fallacy – believing markets are bound to fall just because they are on a winning streak.  
• Interest rate cuts and elections (in the US, UK and India), alongside geopolitical tensions, are likely to be one of the main volatility risks for markets this year.
• There is never a ‘best’ time to enter the market, at least in the absence of hindsight. That said, getting and staying invested is one way to protect and grow your capital in striving to achieve your long-term financial goal.

This year the S&P 500 crossed the 5,000 mark for the first time, artificial intelligence-related stocks are achieving staggering market caps and bitcoin has hit an all-time high. At the same time as investors are observing these market tops, they are also hearing that an economic slowdown is expected this year, as flagged in ‘Global economy fires up the growth engines’. 

It may seem counterintuitive to buy at the peak, just before a bear market. But does that have to be the case?

Markets regularly hit all-time highs

The reality is that the equity market regularly hits highs (see chart). The S&P 500 has ended a month at an all-time high 26.3% of the time since 1950. 

US equities regularly hit all-time highs

The performance of the S&P 500 over the last seven decades and with the number of fresh highs seen in each year shows how common it can be for the index to set a new record

So why do we expect a reversal?

Periods of rising markets can make investors uneasy and fear that a correction is imminent. Why?

The gambler’s fallacy is a situation when we believe the likelihood of an event occurring is influenced by previous event outcomes. Investors might feel that a financial market is due for a correction because it has been rallying for long enough. In the same way, a roulette wheel doesn’t have to land on red on the next spin because the last few have ended up on black, the market doesn’t have to correct simply because of a long rally.

Markets expand and contract with regularity, hence the term market cycle. However, expecting the market to correct simply because it has rallied is the gambler’s fallacy.

Investing at a high need not lead to lower returns

Equity markets have performed well in recent months, with the S&P 500 and MSCI All Country World Index soaring by approximately 25% since their October lows.

For investors sitting on cash, they might be nervous about getting invested today. Have the gains been had, have they missed the boat? 

History shows that subsequent returns from high valuations are low. But while past performance is no guarantee of future results, history nonetheless suggests that investing around highs need not impair the ability to reach long-term goals. 

In order to analyse how much investing at a market high affects long-term returns, the next chart shows the average subsequent total return earned by an investor investing in the S&P 500 on any day since the start of 2000, whether over one, three or five years. The returns are also shown for if the investor had only invested on days when the S&P 500 closed at an all-time high. 

While it is difficult to draw conclusions on one approach versus the other, what is clear is that time in the market matters more than timing the market. 

Time in the market, not timing the market

The average total return earned on the S&P 500 over the subsequent one-, three- and five-year periods since 2000 versus the performance of investing at market highs shows little difference

What explains long-term market trends?

The long-term driver of markets is economic growth, which is frequently down to continued human ingenuity and technological growth. 

The engines of economic growth and strong market performance do not necessarily have to stop functioning simply because they have been running smoothly for some time. Similarly, a surge in a company’s share price does not stop it hitting another high, if the company can continue to generate value. 

That being said, investors should be aware of overconfidence and confirmation bias when expecting that a part of the market will continue to rise just because it has done so before. Positive momentum can also lead investors to act for fear of missing out. 

As always, time in the market is more important than timing it, the latter of which can exacerbate the impact of an investor’s behavioural biases on investment decision-making. 

What next for equities?

The direction of interest rates will be a key catalyst for markets as central banks get closer to cutting rates. How they might react is unclear. However, history shows that previous cutting cycles have translated into mixed performance for equities (see ‘Five charts that matter for investors’). The key determinant will be the health of economies at the time of the cuts.

For now, investors seem to be pricing in a ‘no-landing’ scenario for the global economy. Sentiment (both at the individual and institutional level) appears to be bullish, positioning is extended and valuations are elevated. 

This creates risks, at least in the short term. For one, a significant data surprise which changes growth or inflation expectations, and thus the prospect for rate cuts might pop up. Event risk from upcoming Indian, US and UK elections, and geopolitical factors, are others to be aware of. A market with narrow leadership, such as the S&P 500, is also at risk from changes in sentiment towards those leaders. 

What are the implications for portfolio positioning?

The outlook for the economy and equities might point towards having defensive positioning and bond-like proxies, as highlighted in ‘Time for more defensive equity positioning?’.  

Nonetheless, the long-term prospects for equities seem to be encouraging. Cyclically adjusted price-earnings ratios imply that over the next 10 years the returns on global equities should outperform those from fixed income and cash. 

Given the risks, there are ways to be invested while still being mindful of said risks, as demonstrated in ‘Taming animal spirits: Tail-risk hedging’. Structured products also allow investors to define their payoffs and obtain protection around directional views on markets. There is also no substitute for appropriate diversification, across asset classes, sectors and regions. 

Nuance is also important. People like simple narratives. There can be a tendency to see the market as binary, being up or down, and feeling optimistic or pessimistic. The reality is far more nuanced than that. The key thing to remember is that ‘the market’ is made up of many companies. There is dispersion between them, which also tends to rise in a slowdown. Equities don’t all have to go up, or all go down. 

Getting and staying invested

Volatility is part of investing, and there are many risks on the horizon for investors – general elections, geopolitics and (surprise) data releases which could trigger changes in investors’ expectations. 

Markets can have bad weeks, months and years, but history shows that the value of equity markets has risen over time, as shown in ‘Five charts that matter for investors’.

The journey may well be bumpy, and it could therefore be prudent to hold a well-diversified portfolio, as well as adjusting portfolio allocations to capitalise on opportunities and mitigate risks. It may be prudent to adjust portfolio allocations to gain more exposure to areas of the market that stand to benefit at certain times, or reduce positions that have exposure to negative dynamics.

There is never a perfect time to invest, at least in the absence of hindsight. Regardless, getting and staying invested is a sensible way for investors to protect and grow their capital in order to achieve their long-term goals.

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