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What goes up must come down, right? Not always, when it comes to the stock market.
Despite high unemployment and uncertainty around when we’ll see a coronavirus vaccine, the stock market continues to defy gravity. Headlines about the S&P 500 and Nasdaq hitting record highs and the Dow jumping have been pretty common over the last few weeks.
“All-time high” sounds dramatic, and record-breaking numbers might make you feel like you need to take action. But here’s the thing about the stock market: it’s always breaking records. A record high is a record high only until the next one, says Mike Cocco, financial advisor with Equitable Advisors.
“If you’re a long-term investor, don’t see this as ‘Alright stocks reached an all-time high and that’s it, that's the highest we can go, that’s the ceiling,’” Cocco says. “No, there is no real ceiling.”
The ceiling will always be raised over time because of inflation, the ingenuity of current companies and new companies being formed, he adds. Still, what if you feel uneasy about stocks' improbable rise, and want to take some risk off the table by going at least partly to cash?
The past can teach us the drawbacks to yanking money out of the market during volatility — and we don’t even have to look that far back for a lesson. When the market recovered from its plummet a few months back, investors who had pulled a collective $326 billion out of mutual funds and exchange-traded funds in March missed out on major gains. And if you sat out of the stock market’s 10 best days over the last 20 days, your overall return was halved, according to J.P. Morgan Asset Management.
“Stocks go up a lot more than they go down,” Cocco says. “It’s just that people remember the down a lot more.”
The stock market is not the economy
It can be easy to think that the stock market will reflect the bleak economic news we’ve been hearing as the pandemic has ravaged the labor market. If so many businesses are closing their doors and people are losing their jobs, what is Wall Street celebrating?
The simple answer is that the stock market is not the economy. The stock market is forward looking, so there’s a disconnect between where the economy is now and where investors see the economy going. The health of the economy hinges on a lot of factors going forward, like additional federal stimulus and a vaccine.
“The market is pricing in a good probability of a vaccine, but probably not fully reflecting the upside from a positive vaccine,” says David Lefkowitz, head of Americas equities at UBS Global Wealth Management. In other words, there’s more room for equities to go up on positive vaccine news.
The stock market also doesn’t represent all businesses. Companies in the stock market are publicly traded and include the largest, not the country’s average business, Lefkowitz points out. Small businesses don’t have access to the same type of financing as S&P 500 companies do — they’re much more reliant on banks and federal resources like the Paycheck Protection Program. Many large companies have also been benefiting from the stay-at-home trends seen from the pandemic (think Apple and Amazon), while small businesses are often more service-oriented, like restaurants.
The outlook for corporate profits for publicly traded companies is certainly going to have a correlation with the overall economy, but it may not be a one-for-one correlation, Lefkowitz says.
What it means for your portfolio
So, what should you do with all this? First, rightsize your expectations, says John Stoltzfus, chief investment strategist at Oppenheimer Asset Management. We could very well see volatility return.
“Stocks do not just go up in a straight line,” he adds. There will be news — whether it be a setback in finding a vaccine or drug to better help patients with COVID-19 or about the outcome of the election — that will cause a pullback in the market. No one knows exactly what’s going to happen with the market, or when, and that’s okay. Just make sure to regularly rebalance your portfolio so that it is diversified enough to allow you to take advantage of areas that see gains even while others see losses.
“Anytime you have uncertainty, it invariably creates not just risk,” Stoltzfus says. “It creates opportunity.”
Portfolios will of course look different depending on your risk tolerance and how far out you are from retirement. If you’re expecting to retire in about five to seven years, Cocco recommends a 60-to-40% stock-to-bond split. But if you’re retiring now, you may want to lower that equities portion to 30% and if you’re 10 years out, that equities portion might be bumped up to even 80%, he says.
In short: the fact that the stock market is so high doesn’t necessarily mean we’re going to see a commensurate drop.
Over time, the market steadily rises.
“In the short term markets are wildly unpredictable,” Cocco says. “But in the long term markets are actually wildly predictable.”
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