All-Time High?

While going through Peter Mallouk’s The 5 Mistakes Every Investor Makes and How to Avoid Them, Mallock performed the following exercise: assuming investors jumped in at the worst moments possible throughout the history of the stock market in recent memory (before the 1987 crash, the 1990s recession, before 9/11, at the eve of the financial crisis, etc.), how would they fair?

Unsurprisingly, the long-run growth of the market dominates. As Mallouk noted, S&P 500 is at 1,878 as of August 2014, marking a more than six-fold return for the 1987 investor and a ~30% gain for the investor who invested at the 2007 high.

In walking readers through this simple example, Mallock drives home the idea that timing the market is nowhere as important as jumping in right away with the requisite knowledge. This got me wondering — on average, how long does it take to go from one all-time high to the next?

With S&P 500’s monthly data made available by Robert Shiller, I looked at this very question. The result is quite surprising. While rare economy-wide recessions can depress the market for an extended duration, more often than not, reaching an all-time peak does not entail an immediate “re-adjustment.” As a result, the average period between all-time peaks is just a little under six months (of course, one cannot forget about the six months’ worth of dividends that can be pocketed by investing at the previous all-time high). The histogram below plots the frequency of reaching the next peak within a certain amount of time:

In other words, when you see that the stock market has hit a new high on Wall Street Journal, it makes much more sense to bet that the index will remain on the rise than immediately trending in the opposite direction. Of course, should macroeconomic conditions necessitate a new crisis on the horizon, caution is of course advised. Nonetheless, I find this to be a helpful rule-of-thumb, one more piece of information to help prevent myself from falling into the same psychological traps as others.

A much harder question is that when a crisis appears to be imminent or is just underway, how long would the slump last? There seems to be no way of reliably diagnosing the length. Each crisis is unique. I remember reading somewhere that “if you’ve seen one financial crisis, you’ve seen one financial crisis.” Take the COVID-induced decline, for instance, the rebound was as steep as the decline (which follows the Zarnowitz rule), whereas downturns before have been far milder in magnitude but much longer-lasting. Without specialized analysis, therefore, individual investors should simply head to Mallouk’s advice in the book, which should infallibly prevail in the long run.