I am seeing more and more people leave their pensions in cash because they think we are in a bubble that is going to burst soon. That is when they will swoop in and buy at rock bottom prices and make a killing. When I ask them how they came to that belief, the most common answer is “we get a crash every 10 years, so we are due one”. The market falling -33% in just one month in 2020 obviously doesn’t count as a crash because it recovered so quickly. It felt pretty real to me at the time! But are we in a bubble that is going to burst soon? I don’t think so.
The world of investing has changed a lot over the last 10 – 20 years. The emergence of cryptocurrencies is a new asset class for people to invest in and investors are willing the accept the wild volatility in return for the huge returns they can make from the different cryptos, a lot of which won’t be around in a few years time. The returns on some of these crypto’s are jaw dropping. Siba Inu is one example. Launched on 1 August 2020, it is up 12,733,233% to 30 October 2021. For comparison purposes, the S&P 50o returned 41% in the same period. If you invested $10 in SHIB on launch date, you’d have $1.27 million today. Why would you invest in stocks when you can have those returns?
Well, you could invest in meme stocks. Companies like GameStop and the bankrupt Hertz have caught the imagination of online investors. Through online forums, they have become hugely popular stocks without the fundamental growth or profit to justify their stock price.
Then there are NFTs or nonfungible tokens, which could be an electronic piece or art or an action GIF that the purchaser is the exclusive owner of and which stored using blockchain technology. Again, people are making massive gains on NFTs, a home for people with too much money.
SPACs (SPAC is a Special Purpose Acquisition Company) have been around a long time but have recently become very popular. They are basically an off the shelf plc that has a lot of funding but no actual operating company. They use that money to buy a private company, allowing them to avoid the long, tiring IPO process. They have very mixed results, with a lot of duds. Donald Trump’s social media platform Truth Social is a SPAC for example.
There is no doubt that the cost of buying into markets is more expensive, given the massive returns in the stock market. Add in journalists periodically stoking investors’ record-high anxiety by suggesting the laws of physics apply to financial markets, “what goes up must come down”. “Stocks Head Back to Earth,” read a headline in the Wall Street Journal in 2012. “Weird Science: Wall Street Repeals Law of Gravity,” Barron’s put it in 2017. And a Los Angeles Times reporter had a similar take last year, noting that low interest rates have “helped stock and bond markets defy gravity.”
This creates fears for people who are programmed to think there is going to be a crash because there always after markets have reached highs. But shares are not heavy objects kept aloft through strenuous effort and subject to the laws of gravity. They are perpetual claim tickets on companies’ earnings and dividends. Thousands of people go to work every day, working on projects that will grow profits for the companies that they work for.
Whether at a new high or a new low, today’s share price reflects investors’ collective judgment of what tomorrow’s earnings and dividends are likely to be and those of all the tomorrows to come. Every day, stocks must be priced to deliver a positive expected return for the buyer. Otherwise, no trade would take place. It’s difficult to imagine a scenario where investors freely invest in stocks with the expectation of losing money.
Investors should treat record high prices with neither excitement nor alarm, but rather indifference. If stocks have a positive expected return, reaching record highs with some frequency is exactly the outcome we would expect. Using month end data over the 94 year period ending in 2020, the S&P 500 produced a new high in ending wealth in more than 30% of those monthly observations. Moreover, purchasing shares at all time records has, on average, generated similar returns over subsequent one, three, and five year periods to those of a strategy that purchases stocks following a sharp decline.
1 year later
|3 years later|
5 years later
|After new market high|
|After 20% market decline|
We are conditioned to think that after the rise, the fall must come, tempting us to fiddle with our portfolios. But the data suggest such signals only exist in our imagination and that our efforts to improve results will just as likely penalize them. We should take comfort knowing that share prices are not fighting the forces of gravity when they move higher and have confidence that record highs only tell us the system is working just as we would expect, nothing more.
08 November 2021