Investing at all-time highs

Published in The Sunday Times on 3rd November 2024.

At a conference on the future of finance last week, one of the speakers confidently forecast that the stock market was going to double. He then added – “Don’t ask me to put a timeframe on that  - I am not that naïve.” This wasn’t his first rodeo. He’s familiar with long standing sage advice to market scribes – give a number or a timeframe, but never both. 

Market forecasting hasn’t gotten any easier in my near 30-year career in markets. But I could do with a crystal ball right now. I have some money to invest – but all I can see are problems:

Global markets at all-time highs

The S&P 500 is close to registering its 50th all-time high for the year – and there’s still two months to go. Global indices are also at all-time highs. Investing at market highs feels wrong –  it means paying a price that no one has ever paid before.

Worse still, valuations are high. I’ve clung hard to the edict that the price at which you buy something determines your ultimate return. And the prospective return given today’s valuation looks anemic at best.

And as if that wasn’t enough to contend with, we’ve an unprecedented level of stock market concentration. The ten largest stocks in the S&P 500 account for more than a third of the total market capitalisation of the entire index. Buying the very largest stocks has historically been a losing strategy. So, the market feels particularly vulnerable at this point. 

There’s an awful whiff of market timing to this introduction. I’ve spent a career writing about its perils.  Much like the cobbler’s son with holes in his shoes, I am slow to take my own advice. So I’m writing this as an appeal to myself as much as others; the time to invest in the stock market is now – regardless of when you ask the question.

You need to be very clear about which risk you are trying to manage

I should point out that my objective is to grow the real value of my savings over time. Implicit in this, is that inflation is the relevant risk I am trying to manage. If the risk you are trying to manage is short term capital loss or volatility, you can stop reading, as what follows is incompatible with that objective.

The main psychological barrier to investing when the market is at all-time highs concerns the intuition that a correction is inevitable. But all-time highs are not uncommon – so you would be missing out on a lot of opportunity if you tried to avoid them.

New highs are not that uncommon

In fact, since 1928 the U.S. stock market has on average made 14 new highs every year. Clearly there are several years where the market has not made any new highs at all, and then years like 2017 when it made 62. 2017 was a painful 115% ago if you were using highs as a reason to stay sidelined. 

Rather than cherry pick, here’s how you would have fared if you had invested only at all-time highs versus all other times in the S&P 500 Index using data from 1928-2023. Investing at all-time highs, your average five-year price return (excluding dividends) was 7% p.a. Investing at all other times, your five year return averaged 7.7% p.a. The difference is not negligible, but far less than I would have imagined. The risk of missing out on potential gains seems to weigh more heavily than the risk of permanent capital loss, irrespective of your timing. 

Valuation defines the level of risk

That’s price, which is different to value. Whichever valuation measure we use, we can’t escape the reality that the US market is very expensive. But high valuations alone are not an effective signal for market timing. As Peter Cundhill keenly observed many years ago, “Valuation defines the level of risk. It doesn’t help with timing”. On cyclically adjusted measures of valuation, the US stock market has looked expensive for most of the last 30 years. That hasn’t prevented a generation of investors earning double digit returns. 

While I would prefer to invest when markets are cheap, we must deal with the markets as they are, not how we would wish them to be. That said, US market aggregate valuations conceal cheapness in certain segments and outside the US valuation extremes are much less concerning. 

The Dotcom bubble is not a great comparison for markets today

Anyone that was working in financial markets at the turn of this century will remember the dotcom crash and its aftermath well. The market return and composition were very concentrated in the so-called TMT (tech, media and telecoms) stocks. Concentration today is even higher than it was in late 1999. But there’s a few crucial differences. The small number of mega cap stocks that have delivered the majority of returns have mostly delivered in earnings terms too. These companies are spending vast amounts of capital on AI related initiatives. But they and are so profitable that they can afford to do this without the same equity issuance that marked the dotcom mania. 

Yes, the US market in aggregate is expensive. But the average US stock or global stock is much less so. This contrasts with the late 1990s when the exuberance in TMT spread across almost all sectors and countries.

The time to invest is now

There are lots of imponderables with investing in the stock market – timing being amongst the most intractable. I can confidently say the market will decline. I’m just not sure when, by how much, nor how long the decline will last. The time to invest is now.  

The concerns I’ve raised around price, value and concentration are all valid. So it may make sense to tilt away from the extremes by phasing in, by owning mid-cap indices and diversifying away from the US. 

With markets trading at all time-highs, and with stretched valuations – advocating investing now is a risky limb to go out on. There’s a reasonable chance this article may not age well. But it will only age badly if you are measuring risk incorrectly. 
 

Source: Data is sourced from Bloomberg as at market close 29th December, returns are based on total indices in local currency terms, unless otherwise stated.

Gary Connolly is Investment Director at Davy. He can be contacted at gary.connolly@davy.ie or on X at @gconno1.