“Buy low, sell high” is one of the most time-honored investing strategies. But what happens when the entire stock market is at a bull market, like it is now? Is it a bad time to invest?
That’s one of the toughest questions for investors. Although we know that it’s best to buy when the market is low, we have a natural desire to buy when the market is high. That’s when we watch everyone else make money. It seems like a safe time to invest.
So do you listen to your gut — and invest when stocks are in a bull market? Or do you listen to your intellect — and wait until stocks have headed south?
Unfortunately, there’s no easy answer.
The Arguments for Investing in a Bull Market
Some investors believe you should always be investing in the stock market regardless of overall price levels. There’s solid support for this belief, in terms of both logic and real-world experience.
How High Is High?
It’s easy enough to decide that stocks are high based on the fact that the popular indices are all in record territory. This market is definitely high by that standard.
Still another numeric measuring stick is the price-earnings ratio (P/E) of the market in general.
There’s no question that, by historic standards, the current P/E of the S&P 500 of 22+ is high. That’s certainly true when the market has historically performed best from a P/E of 10 to 14 or lower.
But traditional measures of P/E are questionable. For example, when the 10-year US Treasury Note yielded 6%, a P/E ratio for stocks of, say, 20 was high, because the “P/E” on relatively safe Treasury Notes was 16.7 ($100 divided by 6%).
But in today’s interest rate environment, where Treasury Notes yield about 1.7%, their effective P/E is now about 59.
Given that, a P/E of 22 on stocks isn’t as high as it seems.
Just Because the Market Is “High” Doesn’t Mean It Can’t Go Higher
Just because the stock market looks high at Dow 27,000 doesn’t mean that it can’t rise to 30,000 or even higher. Generally speaking, if stocks are rising, they’ll continue to move upward until an event takes place that stops them.
In an economic environment of low interest and inflation rates, and general economic and political stability, stocks can continue rising. And even if you think they’re too high at current levels, there’s nothing to say they can’t go higher – even much higher – for all for the same reasons that brought them this high in the first place.
There Are Good Investments in All Market Types
No matter how high or how low the stock market is at any given point in time, there are always good investments to be found.
That’s because there are always undervalued stocks. Some stocks are low priced simply because they’re out of favor. Others have had a run of bad luck that has driven the stock price down to a bargain level. Still other companies have such favorable prospects that the future looks bright, even in the face of a potential market decline.
Good stocks are definitely harder to find in bull markets than they are in bear markets. But they’re still out there, and you can continue to invest successfully by favoring such companies.
Your Timing Could Be Way Off
No matter how certain you are that the market is too high – and ripe for a fall – you can still be very wrong. Even people with access to a tremendous amount of technical data are not in a position to predict major market swings.
The biggest disadvantage to reacting “when the market is high” is that you could sell off your positions too early and deny yourself the ability to participate in future gains.
After all, many analysts said stocks were too high back in 2013, when they hit an all-time record of Dow 15,000. But here were are in 2019, and the DOW is higher by 12,000 points.
The Arguments Against Investing in a Bull Market
If you’re at all familiar with the history of bull markets, then you’re well aware that every one of them has ended badly. The worst endings hit the strongest markets. That’s why the word “bubble” is so intimately connected to investing.
What are some reasons why even this seemingly invincible current bull market could be too high?
Gravity Catches Up With Everything – Even the Stock Market
After all the numbers have been crunched – and even ignored – there will come a day of reckoning. One of the problems is that the turning point won’t be either known or even labeled until months or years after the fact.
The problem is that markets don’t grow forever, and neither do the economies that supposedly support them. Eventually, a point is reached where too much credit is outstanding, loan default rates begin to rise, and the consumer has purchased his last widget.
When that happens, even mighty bull markets begin to roll over. As the saying goes, a tree can’t grow to Heaven unless… well, there’s more to that saying, and it’s really unsettling. But that saying also applies to financial markets. And it will to this market in its own time.
There’s a Point When Investing Becomes Speculating
One of the realities that causes bull markets to unwind is that prices do rise to such a level that participation is no longer investing, but speculation.
This happens when the primary reason why people invest in stocks is that prices keep rising. They’re not really concerned with fundamentals, such as revenue or profit growth or even dividends. Instead, it’s a matter of riding out the right wave.
This has also be described as the greater fool theory, in which a fool buys an inflated investment, with the primary purpose of selling it at an even higher price at a later date to an even greater fool. Most bull markets reach this level, though the analogy is totally ignored as long as people are making money.
Investing turns into speculation when the only thing that matters is price.
But the fact is that, even in bull markets, fundamental values matter. Once valuations fail to be seriously important in selecting investments, speculation has taken hold. And unfortunately, speculation-driven markets are subject to the biggest falls.
Perfect Worlds Are More Vulnerable to Bad Events
One of the factors that lead to particularly strong bull markets is a perfect world. Former Federal Reserve Chairman Alan Greenspan referred to it as the Goldilocks economy, and there’s a sense that we’re in one now.
While on the surface that seems like a positive development, it holds a sinister implication for the financial markets. The more perfect the economy seems to be, the more subject it will be to disruption.
What’s worse, the disruption doesn’t have to be that significant. It can be a disturbance in another part of the world, bad earnings reports from a particular industry sector, or even the threat of a disruptive political development. Because everything is so “perfect,” it doesn’t take much to pop the balloon and send the markets into the basement.
Sometimes You Just Gotta Take Profits
We’ve all heard the saying “buy low and sell high.” Naturally, it’s easier to buy successfully in bear markets, and easier to sell in bull markets. That’s when you’ll reap the greatest profits.
And that’s really the whole point. No matter how strong the market seems to be, a high market is always a better time to sell. Sooner or later, every investor has to take profits. The best time to do this is when the market is high and you’ve already built up large profits.
It’s not just a matter of selling at a big profit, either. It’s about liquidating successful investments in order to have cash available to purchase new investments later, and hopefully at much lower prices. But you can’t do that unless you’re prepared to sell at least some of your holdings.
Right now the market certainly seems high, at least based on the numbers. Are you buying, selling, or holding?