by Dianne Lob, AllianceBernstein
Dianne F. Lob and Ding Liu
With the US stock market repeatedly reaching all-time highs in recent weeks, many investors are becoming leery of investing in stocks. Focusing on the market’s level is a mistake, in our view. It’s market valuation, not level, that matters.
Since 1900, the S&P 500 Index has been close to (within 5%) of its prior peak almost half the time. There’s a simple reason for this. The stock market goes up over time, along with the economy and corporate earnings. As a result, the market typically has regained its prior peak level fairly quickly after dropping. Then, it has resumed its upward march (Display 1).
Fear of investing at market peaks is understandable. In the short term, there’s always the risk that other investors will decide to take gains, or that geopolitical, economic or company-specific news will trigger a market pullback.
But for longer-term investors, market level has no predictive power. Market valuation—not market level—is what historically has mattered to future returns (Display 2).
The green bars on the left side of Display 2 show average market returns after points at which the market level was close to its prior peak. The dotted line shows average market returns after all points since 1970 (we don’t have good valuation data before then). Over 1-, 3-, 5- or 10-year periods, annualized returns were about the same after points at which the market was close to its prior peak level as after all points since 1970.
Display 2 also shows that buying when the market was at least 5% below its prior peak level (indicated by the blue bars) didn’t help much. It added slightly to annualized returns over 1- and 10-year periods, but detracted from returns over 3- and 5-year time periods.