Should You Buy Stocks When They are at All-Time Highs?

The short answer is: that’s not what you should be focusing on. Instead, investors should be asking, “at today’s valuation, is it a good time to invest?” 

Investing at all-time highs may seem scary for investors. We are told to buy low and sell high and buying at all time highs feels like the opposite of that basic mantra. 

The market has been booming in the last five months, rising 21% since Halloween before the recent pullback. This rally has been far broader than the rise from late 2022 through 2023 where artificial intelligence (“A.I.”) euphoria drove the results. 

Challenging the Golden Rule of Investing: Buy Low, Sell High

_{^{Source: YCharts, as of 05/03/2024. Graph illustrating percent change over time.}}

Many investors would baulk at putting new money to work after such a run. However, research shows that all-time highs are typically followed by all-time highs.  

According to CD Wealth, since 1950, there have been only 30 occurrences in which the market rose for at least five consecutive months. In those occasions, the average return has been 12.6% over the following 12 months, and it has been positive 93.1% of the time.¹ 

The thing investors need to realize is that markets are cyclical and can significantly overshoot both to the upside and the downside when the cycle turns. This is why market volatility can be the highest during those downturns and new highs tend to primarily occur during those uptrends. 

Since the 1990s, according to Ritholz Wealth Management, the S&P 500 has been at an all-time high 12% of all trading days (or 1 out of every 8 market days). Relatively speaking, that is a high number.  

Over the last decade, the number is even higher at one out of every five trading days or almost 20% of all days the market was open.  

Nothing is ever guaranteed but not investing just because we are at all-time highs is not a sound strategy. 

In fact, according to J.P. Morgan, investing on days where the S&P 500 closed at a new all-time high can actually produce better returns than investing on a day where the market didn't set a new record. 

_{^{Source: FactSet, J.P. Morgan Private Bank, data as of 08/27/2020. Chart comparing average cumulative S&P 500 total returns.}}

They found that if you had invested in the S&P 500 on any given day since 1988, your average total return a year later would have been just shy of 12%. 

However, if you only invested on days where the S&P 500 closed at an all-time high your average total return would be nearly 15%.² 

The average returns were better when you bought at all-time highs! These results are counterintuitive, but they make sense when you consider all the behavioral biases we exhibit as humans. 

It is valuations that are far more critical about the timing of new purchases. 

Forecasting Market Returns with the CAPE Ratio

There is something called the CAPE ratio. This is short for cyclically adjusted price-to-earnings ratio or the long-term multiple of earnings that the market is trading at. Currently, that CAPE ratio stands at 34x. Over the long-term, the average CAPE ratio has been 17.1x. 

Looking historically at different ranges of when you invest at specific CAPE ratios, you can see the 10-year S&P 500 annualized returns that followed. Said another way, we can see the returns for the market over the next ten years at various levels of the CAPE, a measure of valuation.  

_{^{Source: Jivraj, Farouk and Shillfer, Robert J, The Many Colours of CAPE (October 13, 2017). Yale ICF Working Paper No. 2018-22.}}

Remember when looking at the above table, we are currently at a CAPE ratio of 34. We would clearly fall in that last line where the range is 26.4 – 44.2 with an average of 33.2.  

The real mean annualized return of the S&P 500 from this valuation level is just 0.9% per year. Yes, you read that correctly. Now, that is a “real” or after inflation number so if we simply add a generic long-term inflation rate of 3.0% to that, we get a nominal 3.9% annualized return of the S&P over the next 10 years. That is a very low number relative to the average return of the market that is near 10%.  

However, it is extremely important to understand the wide dispersion of potential outcomes as the worst 10-year real return was -6.1% and the best was +5.8% per year. In other words, starting valuations don’t necessarily result in poor outcomes. 

What’s important though is that we are in that bottom (worst) line and not the top two when the CAPE is below 12.1x and even the worst 10-year outcomes are decent nominal return years.  

The conclusion is not that you shouldn’t own stocks here. However, investors do need to be careful when you look at it from the perspective of valuations rather than all-time highs.  

Additionally, we should note the predictive power of this exercise has a very wide degree of potential outcomes. Investors should not overestimate the power of this exercise in predicting future returns. Instead, it should be used to help determine how much risk should be taken given the investors specific plan, risk tolerances, and objectives. 

In other words, just because it shows that average returns will be lower based on historical data doesn’t mean it HAS to be lower.  

Seizing Bond Opportunities

Today, the market is giving us a generational opportunity to own bonds. The last time bonds were this investable was in the mid-2000s, about 20 years ago. For investors in the ‘danger zone’ for investing, a.k.a. the 5 years preceding and 10 years following their retirement date, it makes far more sense to own bonds and net about 5.5% per year with a high degree of probability versus owning stocks when they are in the richest decile of observations going back to 1926.  

That doesn’t mean we get fully out of stocks but from a practical and prudent risk management perspective, we want to allocate capital where we see the most certainly and most amount of return per unit of risk.  

I recently made a short-form video about investing at all-time highs. Check it out and follow me on your preferred social media platform: 

As always, we value the trust you place in our managing of your hard-earned capital. 

If you have any questions, please do not hesitate to contact us. 

Sincerely, 

Mark J Asaro, CFA 

_{¹ https://www.cdwealth.com/article/debunking-market-timing/}

_{² https://privatebank.jpmorgan.com/nam/en/insights/markets-and-investing/tmt/6-top-questions-for-investors-today#}