If you’re a sports fan, you’ve probably heard some variation of this cliché from players and coaches alike: “To be successful, don’t get too high after the wins or too low after the losses.”
You hear it in sports so often for a reason. There’s a lot of truth in that saying — and it may even be more true for investors than athletes.
Some of the biggest investment mistakes people make happen when their emotions dictate their investment decisions, driving them to buy when they feel good and sell when they feel bad.
With the S&P 500 and Dow indices hitting all-time highs in recent weeks, now is a good time to stop and take a pulse of investor sentiment to see if you’re at risk of getting too high after recent market wins.
What Caused the Best First Half for the S&P 500 in Over 20 Years?
After a disappointing May, the market rebounded strongly in June. The S&P 500 finished the month up 7% and ended the first half of the year up 17%. That’s almost double its long-term average annual return and the market’s best first half since 1997.
The two primary catalysts of the June rally were the Fed’s perceived shift in interest rate policy and a thawing of tensions surrounding the trade dispute between the U.S. and China. But if you take a closer look at both themes, you might find there’s good reason to hold off on popping the champagne in celebration.
Despite Good News in the Short-Term, the Fed Might Feel Concerns About the Future
During its June meeting, Fed officials indicated that a rate cut was likely in the near future. While the market expected such a signal, this confirmation from the Fed left investors in very positive spirits after four rate increases last year.
The market likes lower rates because it incentivizes consumers and businesses to borrow money and spend, which is good for the economy. As a result, stocks climbed higher on the Fed news.
But normally at this point in the market cycle, the Fed is raising rates to offset higher inflation and prevent the economy from overheating. In other words, the economy can get so strong that it risks growing too fast.
The Fed raises rates to slow its speed to maintain the economic expansion over a longer period. This is good in the short-term — but the fact that the Fed feels compelled to consider cutting rates suggests they might feel the economy needs a little help. That’s not a great sign for the long-term.
The U.S & China Trade Dispute Is Looking Better – But Unlikely to Be Fully, Swiftly Resolved
Surprising as it may be, the trade dispute between the U.S. and China has been going for over a year at this point. It began in March of 2018 when President Trump requested consideration of imposing tariffs on China.
Since then, the market has been taking a frequent temperature of the ongoing negotiations. The readings show both market and investor sentiments tend to shift like changes in the wind.
It was the perceived pessimism regarding a resolution that dragged markets lower at the end of 2018. That pessimism shifted to optimism in the best first quarter since 2009 only to reverse course yet again in May, when negotiations broke off and additional tariffs were threatened.
Cooler heads prevailed in June as the two countries agreed to postpone additional tariffs and return to the negotiating table. Stocks rallied on the news that the world’s two largest economies were once again working towards a resolution.
But just like a sports team on a winning streak, investors need to be wary of getting too high following this most recent news.
After all, the market rallied on the fact that the two countries would resume negotiations, or resume even talking to one another — not because there have been positive steps towards an actual resolution.
Each country has some significant concerns that are unlikely to be resolved swiftly given the slow pace of negotiations to this point. The tariffs and the uncertainty they create for business investment and personal consumption will continue to serve as a drag on both U.S. and global growth. This economic drag from the trade dispute has been a large contributor to the Fed signaling a future rate cut.
Not Too High, Not Too Low: Investors Need to Maintain an Emotional Balancing Act
These concerns are not to suggest that the sky is falling. Investment mistakes happen not just when people feel panicked about what the market is doing… but when they feel overly optimistic about it, too, which is why we need to be careful here.
“Careful” means not letting your emotions swing too much in any direction, positive or negative. While we’ve covered some reasons why you don’t want to be too jubilant about recent market headlines, there are also plenty of reasons to feel positive within reason.
With unemployment near its 50-year low and wage growth hovering around 3%, the health of the consumer remains upbeat. Corporations are expected to see positive earnings growth again in 2019 and a low interest rate environment should also contribute to support the growing economy.
These market fundamentals should help the now 10-year economic expansion continue. Even as it does so, keep in mind that a hallmark of a market cycle is that as the cycle ages, the risks to the downside become more balanced with the potential for further upside.
This balancing of headwinds and tailwinds results in additional market volatility and uncertainty for investors. While the new market highs to close the quarter left many investors in positive spirits, follow the composed lead set by your favorite sports teams and coaches during post-winning-game press conferences: don’t get too high or too low.
Many investors get complacent with the level of risk in their portfolio during bull markets, forgetting the pains from the last significant market decline. One great way to avoid this is to review the balance of stocks and bonds in your portfolio to ensure the amount of risk you’re taking aligns with your actual comfort with risk.
By reviewing your diversification and keeping a focus on long-term financial goals, investors can avoid getting too high — even after the recent market all-time highs.