Quiz any random group of investors, and you are likely to hear that the stock market is overvalued. Contrarians, convinced that the crowd is often wrong, will tack away from the popular view. But sometimes, the crowd is right. This is likely one of those times. By most accepted measures, the market is rich relative to historical norms.
This presents a psychological dilemma for long-term investors. Should they forge ahead despite the belief that stocks are expensive, or should they wait for a selloff before committing their capital? And if already fully invested, should they stay put or bail out now to avoid the inevitable correction that seems always to lurk just around the next corner?
Most investors by now actually know the right answer. Given the wealth of information available on financial media and the internet, the futility of trying to time the market is widely accepted. And yet many of us still try, against our better judgment and despite previous lessons learned. But for this potent human trait, Las Vegas would still be a forlorn way station.
It is far more important to calibrate expectations and focus on things that are controllable, like asset allocation and risk management, and allow Father Time to work his magic.
Christopher HopkinsSetting reasonable expectations should include reducing our expectation for stock market growth over the next few years. Markets run in cycles, with valuations peaking and then overcorrecting. This phenomenon, often referred to as "reversion to the mean," simply implies that stock prices fluctuate about the average over what can be very long cycles.
The value of the S&P 500 index is currently about 50 percent above average, based upon earnings over the past 12 months. Other metrics that smooth earnings over a longer time period come up even more inflated, and even values based on predictions next year's profits reflect a 20 percent premium. Stocks are expensive.
This does not suggest we avoid the stock market, or play the loser's game of timing it. It tells us that we should reduce our expectation for the return of our stock portfolio for the next few years. Statistical studies based upon past performance suggest that average returns on the S&P 500 over the next five years may fall within the range of 3-6 percent per year, if the pattern of the last 90 years can be interpolated into the future. This is not a prediction, and the experience of late 1990s serves as the exception to the rule. But all things equal, long periods of outperformance are followed by intervals of underperformance. We know not if 2018 will signal the great reversion to the mean, but the odds favor it.
So what to do? If only we could know with some certainty when the correction will begin, we could implement the perfect hedge. But the only thing we know with certainty is that we know nothing with certainty.
If you are invested, stick with the program. Take time to rebalance among asset classes if you have not done so in the last year. Reassess your time frame and adjust your degree of stock exposure accordingly.
If you are putting cash to work, and can't stomach a full commitment, consider the time-tested practice of dollar cost averaging. Begin putting cash to work systematically according to your allocation plan over a period of time, say three to six months.
Markets are relatively expensive, but many more investors have missed gains than avoided losses by trying to time the market. Make a plan, and stick to it. And turn off CNBC.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co. in Chattanooga.