By Tim Courtney, Chief Investment Officer at Exencial Wealth Advisors
During the past six weeks, the S&P 500 crossed 5,000 for the first time and remained above that threshold1, while the Nasdaq hit a new all-time high of 16,274.94 on March 12. Across the pond in Europe, the GRANOLAS stocks (people love making acronyms out of company names) also led the STOXX 600 index to a historic peak3. These record highs often raise questions from investors: Is this cause for celebration, or should we brace for a downturn?
The answer is that our current circumstance of markets at new highs is normal and that market highs are not by themselves a cause for excitement or concern. Historical data reveals that about 30% of all month-end valuations are new all-time highs. As such new highs are not rare, which is good because investing in markets which go decades between highs is not very fun.
Seeing a new high in markets also doesn’t give us insight or more accurate predictions on what future returns will be. Our research indicates that market returns following record highs are similar to returns following any other market period. Market performance after a new market high or even after a 20% decline is on average about the same – roughly 10% annualized returns over the next three and five years4. Just because a market reaches a new all-time high doesn’t mean we should expect much different future expected returns.
What we should be paying attention to, however, are the prices we're paying for stocks during these highs. Are these new highs supported by solid fundamentals like earnings growth and a strong economy? Are investor expectations for future growth and risk reasonable, or are they overly optimistic? In other words, do stock prices appear expensive relative to their fundamentals and future growth potential?
When we evaluate the price of markets, we want to look at price scaled by some fundamental measure. We might look at price/earnings, price/book value or price/cash flow. If markets are hitting new highs while the economy and earnings are growing well, that is healthy and expected. But if markets are hitting highs and prices and moving higher than the fundamentals, that may not be as healthy. We need to examine why that might be happening.
Currently, broad markets don’t seem overpriced. But, there's a noticeable sliver of the market, within US large companies, within the tech/communications sectors, especially within AI related names, that does look pretty expensive5. Prices in some of these companies are growing faster than their earnings and assume extremely optimistic future growth. This is something that we are concerned about because while history doesn’t have much to say about markets hitting new highs, it does indicate that after valuations become elevated, future returns tend to be lower.
When you see headlines highlighting that markets hit a record high, remember this is a fairly common occurrence and the reason we invest. We do however want to remain disciplined about how we invest and the prices we pay for the assets we own.
Sources
PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RETURNS. Information and opinions provided herein reflect the views of the author as of the publication date of this article. Such views and opinions are subject to change at any point and without notice. Some of the information provided herein was obtained from third-party sources believed to be reliable but such information is not guaranteed to be accurate. In addition, the links provided within are for convenience only and the provision of the links does not imply any sponsorship, endorsement, or approval of any of the content. We do not guarantee the content or its accuracy and completeness. The content is being provided for informational purposes only, and nothing within is, or is intended to constitute, investment, tax, or legal advice or a recommendation to buy or sell any types of securities or investments. The author has not taken into account the investment objectives, financial situation, or particular needs of any individual investor. Any forward-looking statements or forecasts are based on assumptions only, and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Any assumptions and projections displayed are estimates, hypothetical in nature, and meant to serve solely as a guideline. No investment decision should be made based solely on any information provided herein and the author is not responsible for the consequences of any decisions or actions taken as a result of information provided in this book. There is a risk of loss from an investment in securities, including the risk of total loss of principal, which an investor will need to be prepared to bear. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Exencial Wealth Advisors, LLC (“EWA”) is an investment adviser registered with the Securities & Exchange Commission (SEC). However, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. EWA may only transact business in those states in which it is registered, notice filed, or qualifies for an exemption or exclusion from registration or notice filing requirements. Complete information about our services and fees is contained in our Form ADV Part 2A (Disclosure Brochure), a copy of which can be obtained at www.adviserinfo.sec.gov or by calling us at 888-478-1971.