When Things Go Too Well

We've been noticing a common theme emerging in the popular press lately, one that we can't quite get our heads around. It can take many forms but follows the same general logic. Usually its "what goes up, must come down," "the calm before the storm," or some other neat prognostication to the same effect. In a nutshell, it seems as most commentators are calling for a fall in the stock market because…well, simply just because nothing bad has happened in awhile. We could also say that we expect it to snow in San Francisco next week, for the only reason that it hasn't in quite some time. That's just as relevant of a statement.

One statistic we found particularly odd: the US stock market is on its longest run without a daily 2% decline since 1954. So what. Stocks are not serially correlated. The price movement of prior days has nothing to do with the movement today. In other words, just because stocks haven't declined by 2% in a day recently doesn't necessarily mean that they're due for such an event anytime soon. Might happen, might not.

In any event, even if a 2% decline or some other fall is imminent, what exactly are you supposed to do with that information? You can't know when a correction is coming. By definition, it comes out of nowhere, on no significant news.

One thing is for sure; you shouldn't even think about trying to time it. It costs too much. Not only are there transaction costs but the chances of you timing the event perfectly are essentially nil. And that means you may miss out on a big up day, which would really hurt. For example, if you missed the 10 best S&P 500 trading days since 1982, your average annualized return would drop from 10.7% to 8.3%. That's a really expensive bet for something you can't know for sure.

Either way, bull markets don't die just because they're tired or because of some eerie calm. New bear markets need some type of euphoria to start. That's when you should sit up and really pay attention. But you're not going to hear about it in the press at the time. That's yet another reason why you should ignore all the worrywarts calling for a fall just because things are going too well.