Should you invest when stocks are at all time highs?

Have you ever felt uneasy about investing when the market is nearing all time highs? What if a crash happens or it declines right away?

In this episode we look to history to help inform what investors should do in this potentially tricky situation.

--
TAX CHANGES: Budget 2024

XEQT vs VEQT. Which ETF is better?

Add some STRESS to your retirement plan

Connect With Evan

Transcript

Speaker 1: 0:08

Hello and welcome back to the Canadian Money Roadmap podcast. I'm your host, evan Neville. On today's episode, I'm going to be answering the question of should you be investing in stocks when the market is at an all-time high? I got this question a few times recently, and so I thought I'd break down a few of the things that I think about when answering this question. There's a few numbers and percentages and all sorts of things in the answer here, so I'm breaking this into two parts, and so this is part one of answering the question should you invest when the market is at all-time highs? When the new year rolls around and everybody has their new TFSA contribution room, a lot of people start asking this question. I've seen it online. I got this question from existing clients and it's fair, especially after looking at a great year for the stock market, like we saw last year, especially in the US. I know a lot of you listening and a lot of my clients would have more of their money invested in US stocks than Canadian stocks or international as well, and so if the S&P 500 is close to all-time highs, the question inevitably comes up, and this has happened before, not just right now, but it comes up all the time. If the stock market is at an all-time high, should I wait to make a new investment just in case it crashes now that it's at an all-time high? There's a few things to break down in there and perhaps a few misconceptions, so I'm going to chop this up into a few different sections and in this week's episode I'm going to look at some data that tell us what has happened in the past, and next week I'm going to talk about valuation and how that might be different than understanding just the price level of any sort of investing index or anything like that. Okay, so let's get into this. So currently, our price is actually at all-time highs. That's a fair question to ask. If I'm looking today at the S&P 500, it's pretty darn close actually. So last year was pretty good, 2022 was pretty rough, and so the last time we saw an all-time high for the S&P 500 was back at the end of 2021. We're looking at Canadian stocks. We're not quite there yet, but it's not too far off, so the question probably remains. For stocks in general, yes, returns were good broadly speaking around the world last year. A few anomalies here and there, I guess, but some markets were great, some were poor, but almost universally back in 2022, things were pretty rough, so we're kind of making up for a previous year there, and so pretty much any pure stock index that you look at has this kind of deep V. That happened 22, 23, and here we are now. So we're either approaching or at all-time highs for most stock indexes that the average person is going to be taking a look at. You can look at the US, canada, japan, germany. They're all pretty well close to their respective all-time highs. So, yes, this is a fair question to ask, given where things are right now. So, number two why does that make some people nervous? Well, the fear is that if prices are at all-time highs, they're more likely to drop. The idea that stock prices reflect some sort of cliff that eventually happens. No one wants to invest money if they think they're going to lose money, and so if an all-time high represents an impending collapse, then this sounds reasonable. So a fewPodcast countries have chosen to pop now a Franz 레�о jog toาน LED speakers back to London. When I answer this question, or I take a look at this, I want to base my decision on data and good data, and an abundance of it, so that I'm blindly doing one thing or the other. So I would like to take a little bit of a closer look at what the data tell us. So I'm going to get this information from Dimensional. I've talked about Dimensional on the podcast before, but they are kind of the pioneers of evidence-based investing and they put out some really great research on various investing topics and this was one of them from last year. So their title for this bit of research. They said why a stock peak isn't a cliff, and what they did was they said okay, well, let's take a look at what performance has been on a one, three and five-year basis after the stock market had reached a previous all-time high. So they looked at the S&P 500 and they looked at the monthly closing level, so whatever the price was at the end of the month between 1926 and 2022. So we've got over a thousand months within that period of time to evaluate. And so when they looked at the price levels during those near 100-year period of time, they found that 30% of those months were new highs. So what they did from there is you can take a look at what the returns are after those periods of time. But also when you have a large data set like that you can find out what the returns are for a random month or the average of any month throughout the entire period. So this was really interesting. So they found that 30% of the months were at all-time highs. So this is very common. Okay, this isn't a you know odd event, but that also makes sense. They kind of add this at the end of the research here, and I'm just going to read it verbatim, because they nailed it it says that stocks are priced to deliver a positive expected return for investors every day. So reaching record highs with some regularity is exactly the outcome one would expect. This makes good sense, right? If the stock market represents what the average investor or the collective of investors have deemed to be the fair price for businesses that are growing and selling and producing things, there is an expected return for these types of things, and so if there's an expected positive return for it, they've got to be at all-time highs relatively frequently. So, without getting into too much theory here, let's hop back into the numbers. So let's just look at the months that ended at a record high. Now, for those of you that are just listening to the podcast, I'm going to have a YouTube video where you can see this graph. So if you're a bit more of a visual learner, hop over to YouTube and you can find the video with a similar title here and I'll be walking through it so you can see the graph a little bit better. But for the months that ended at a record high, one year later the average return one year after the market was at an all-time high 13.7%. That is pretty darn good. And then three years later, 10.6%. Five years later, 10.2%. Small caveat here that these are not any sort of ETFs or investment that you can actually buy, but this is just the return of the index. Yeah, you can buy index funds that are getting pretty close, but it's just worth throwing the little disclaimer in there. But for one year performance 13.7%. After One year of an all-time high. That is nearly double what you would expect in a given year, especially on a go-forward basis. Again, here's my another little caveat. But past performance is not a guarantee of the future results. But after a hundred years we've got enough information here that tells us something, right? So let's talk about the months that ended at any level, not just the ones that Ended at an all-time high. So for a random period of time or a random starting point. One year later, the average return was actually only 12.4 percent. So on a really short-term basis, historically speaking, only your Returns have been higher when investing at all-time highs than any other random month. Not exactly what one would expect. If you're asking the question of should I wait to invest after the stock market's an all-time high, this might point to a little anomaly called momentum, the momentum factor, where stocks will kind of continue going in an upward trajectory. Perhaps it's because of enthusiasm or Excitement or things like that, but there's, there's a momentum factor that comes into play a little bit. That is really hard to quantify from an academic level, so maybe this is part of momentum coming into play here. So again, any month throughout this period of time, three years later, 10.7 percent and five years later, 10.3 and these are each 0.1 percent higher than the returns that we've seen in the past. For the months that ended at an all-time high, again those were 10.6 and 10.2 respectively. This is not a meaningful difference of 0.1 percent over five years or three years to make any sort of decision based on timing. Right, if we're seeing that five years later you're more likely to have lost money Versus a random month where you would have gained 10.0 percent, it's like, okay, there's, there's something here. Right, there's, there's a potential market timing Opportunity here, but the data does not show that. Okay, so when? If you're just looking at average returns, like we did, they've been objectively great, even when investing at all-time highs. But in terms of the number of times they were up, so a year later after being at an all-time high, 81% of the time a year later, it's positive again, and 86% of the time after five years, okay, this is not a coin toss, this is just what it has been. Again, it's not a guarantee and it's not a hundred percent, but it's pretty good. My belief would be that the data does not actually point to any sort of Market timing strategy that you could be employing here, by waiting it out after the market hits an all-time high or anything like that. So my conclusion is that, well, there's always a chance of the stock market could decline immediately after you make an investment. It could definitely happen, doesn't matter where the price level is. The data Do not support the idea that a stock market high is a predictor of an impending crash or a ceiling on potential returns or anything like that. So, as a result, I do not recommend that people try to time when they make new purchases based on the current level of their respective benchmark. So maybe that's the S&P 500. Maybe that's the TSX, maybe that's something else. Side note if the S&P 500 is at an all-time high but you're a bond investor, or if you're looking at Canadian stocks only and you're trying to do some sort of market timing thing based on this, you're comparing different things anyways, and this is kind of a moot point. This is something that I see all the time. So for someone that says, well, the stock market's at an all-time high, but half their portfolio is planning to be in bonds even if this were true, you need to look at a broader data set that includes something about bonds, but that's not what the data says anyway, so we can thoroughly ignore that. So what I hopefully have summarized here is that, yes, it's reasonable to think that, potentially, the market could decline after reaching an all-time high, but if we use history as a guide, the data does not support that idea at all. So if you are waiting to make your new TFSA purchase, I would say do that at your own risk, because making a TFSA contribution at the beginning of the year likely means that you've already maximized your contributions there and the value that you get from investing in a TFSA is the longest time in the market to eliminate taxes on investment growth. The sooner you can get your money in there, the more likely your odds of success actually are over a long enough period of time. So this episode I just took a look at what the returns have been and how often they are positive, based on the market being at an all-time high. What I didn't talk about here at all is whether an all-time high is actually reflective of anything. An all-time high does not mean that stocks are expensive, and an all-time high does not signal any sort of trouble. The price of a stock is not necessarily reflective of the valuation. We have to look at something else. So it's price relative to something else, and so that'll be part two next week of another way that we could take a look at investing at all-time highs from the perspective of looking at valuation. Thanks so much for listening to this episode and we will see you next week with part two of this series on investing at all-time highs. Thanks for listening to this episode of the Canadian Money Roadmap Podcast. Any rates of return or investments discussed are historical or hypothetical and are intended to be used for educational purposes only. You should always consult with your financial, legal and tax advisors before making changes to your financial plan. Evan Neufeld is a certified financial planner and registered investment fund advisor. Mutual funds and ETFs are provided by Sterling Mutuals Inc.