With the stock market off to a strong start in 2013 we are back to levels nearing all time highs. Actually small and medium sized stock indexes have established new record highs, while the index of larger stocks, the S&P 500, is several percentage points away from its record reading.
When the stock market is doing well, there is a tendency for some people to want to sell, and for others to want to buy. For those who want to buy, they tend to be trend followers. This approach may work in the short run, but is normally not a good approach for the long term investor. Someone would need to be a skilled trader for this approach to work, and most people are not.
For those who would want to sell when the market is high, there is more logic to that strategy, but it is not necessarily the best approach. People who follow this strategy seldom lose money in the market, but do not particularly achieve large gains. The buy low and sell high strategy works best in sideways markets.
The best approach to follow is to attempt to determine how reasonably valued the market is, when it is at a high. For example the S&P 500 is now trading at levels that it first reached in early 2000, but earnings for the market are approximately double today compared to where they were in 2000. Based on current earnings, the stock market’s price today is about normal compared to long term averages.
Another point to consider is that establishing new highs in the stock market is not unusual. Earnings tend to grow over time, as the economy grows both in the United States and increasingly throughout the world.
There have been times throughout history, such as the 1980s and 1990s when the stock market would establish a new high, and then double or triple again in five to 10 years. Many people have seen this occur with their own homes, which could be at a record price and then continue to increase in price significantly years afterward.
The U.S. economy is not growing as rapidly now as it has in past decades. This may tend to limit the types of stock market gains that were achieved in prior periods. Nevertheless, with overseas earnings becoming increasingly important, the stock market should still continue to set new highs over time.
With the recent rally this would be an opportune time to review investment accounts. For example, for someone has a target of 60% stocks in their account, and appreciation has increased that figure to 70%, then this would be a good time to reduce that weighting. Also, if an investor is invested in smaller and medium sized companies, which are relatively more expensive than large stocks, I would reduce those holdings first.
The stock market has rallied recently, since some of the worst fears, such as a collapse of the euro and falling off the “fiscal cliff” domestically have not materialized. Even though the stock market is near record territory, I do not believe investors need to make significant changes other than adjusting weightings in various asset classes.
