News that stock markets are reaching new all-time highs can be taken two ways by investors.
On the one hand, higher market levels mean portfolios have probably risen in value. That’s always welcome. But on the other, it means that those investing now face buying when prices at an aggregate level are already high.
It’s basic investing logic that buying high leaves less room for returns in the future. Some might even be tempted to pause their investing until a more attractive entry point comes along.
But this simplistic logic does not tell the full story. In fact, when you consider the long-term behaviour of markets, sitting on the side lines when markets peak could be a mistake.
New Year, new high
First – let’s be clear on which market has hit an all-time, and why. The S&P 500 is the index which has now broken new ground, first hitting a new record closing level last Friday and then exceeding it on consecutive days this week to sit at 4,868 points by the close of play on Wednesday.
Claims of ‘stock markets hitting new highs’ are justified on the basis that the S&P 500 is the headline index for the world’s largest stock market, and the one that investors will likely have the most exposure to.
Not all stock markets are in record territory. At a global level, measured by the MSCI World Index, stocks markets remain slightly below their record high set in December 2021.
The S&P 500 is weighted by market capitalisation, meaning the biggest companies take up a bigger share of the index. That matters a lot right now because the bulk of returns have come from a relatively small number of the very biggest companies. The all-time high achieved last week is mostly down to their strong performance. You can read more about those ‘Magnificent 7’ here.
Beyond these names, the market has risen by far less. An index which applies equal weighting to all S&P 500 companies is still 5.5% below its high water mark. Meanwhile, the Russell 2000 index – which represents US small and medium sized companies – remains some 20.9% below its all-time high.
Market highs – lessons from history
For investors worried about investing when markets are near record highs, it’s worth understanding the returns that have been achieved following previous moments when new records have been set.
Using data going back to 1971 it’s possible to identify each occasion the market has reached a new high – there have been many hundreds – and then work out returns from those dates.
The chart below shows the average three-year and five-year annualised returns achieved by investing when the S&P 500 has hit an all time high. You can see that returns from these moments have been only marginally lower than the long-run average across the period.
The annualised 5-year return dips from 11.2% to 9.7% when investing at a market high – lower but still very healthy.
