Note from the CIO: Is it safe to invest when the market is at all-time highs?

I was asked more than once by Abacus clients last quarter if it’s wise to invest in the stock market near “the top.” The S&P index of the largest 500 US companies reached yet another all-time high of 3,025 on July 26, up 19% through the first three quarters of the year; causing investors to wonder anxiously if now is the time to reduce their stock positions (even more than standard rebalancing would suggest); and leaving potential investors who have been sitting on the sidelines feeling paralyzed with doubt over what to do. At Abacus, we discuss with our clients early and regularly how markets will gyrate unpredictably, up and down. Yet no one wants to see their portfolio value decline after deciding to stay invested or investing new money.

Last quarter, I explained that we have gone through two great bull markets since World War II that lasted significantly longer than the current run-up (since 2009) and with considerably more growth, calling into question the statement that the current expansion cannot last much longer. But how important is it to avoid investing at an all-time high? If you invested your money in March of 2000 or October of 2007, that would have been unfortunate timing because both of those turned out to be market peaks followed by roughly 50% drops. But the vast majority of other initial investment dates in the past would not have been as bad, or bad at all. So, let’s try to understand better this risk of getting the timing wrong.

A recent study[1] of monthly S&P 500 returns (including dividends) looked at what would happen if you had invested in any month since 1945. These months included the all-time highs (about one-third of the months) as well as the “regular” months. The results are summarized here:

Historical Odds of a Drop After Investing

In 72% of the starting months, your money would have dropped by some amount below the initial investment at some point, which means that in 28% of the cases your money never dropped below the initial investment amount. In half the starting months, you would have experienced at least a 5% drop at some point below your initial investment; and in only 22% of the starting months you would have experienced a bear market drop of 20% or more.

These seem like reasonable odds for a long-term investor. But we are not at a random starting point – we are within 2% of the last market high as I write in early October, 2019. Fortunately, the study also addressed this specific issue, and this is where it gets even more interesting. If we limit the starting months to only the one-third that were at all-time highs, the results get better:

Historical Odds of a Drop After Investing

We see that only two-thirds of the time would we have experienced any drop; and only 41% of the time would we have experienced a 5% drop or more; and only 15% of the time would we have experienced a bear market drop, all lower chances of a drop than investing during a random month.

“This sounds counterintuitive,” the study rightly observed, as it calls into question the assertion that investing near an all-time high is a mistake. “But investors should remember that for every 2000 and 2007, when buying in at all-time highs subsequently turns out to have been a bad idea, there were many more 1982s, 1992s, 1995s, 2013s and 2016s, when investors were richly rewarded for taking a leap of faith.”

Quite well said. Although after studying the data above, I’d recharacterize “taking a leap of faith” as “acting rationally in the face of uncertainty.”

[1] “All-time highs don’t mean drawdown risks are higher“, July 12, 2019, UBS