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How to interpret the Stock Market reaching new All-Time Highs on unexpected GDP growth Thumbnail

How to interpret the Stock Market reaching new All-Time Highs on unexpected GDP growth

Fyodor Dostoevsky once wrote, "Man only likes to count his troubles; he doesn't calculate his happiness." The idea that the glass is always half empty perfectly captures how many investors feel about the economy and financial markets, especially over the past few years. 

Investors worry that the situation will never improve during recessions and bear markets. When the economy and markets recover, investors fear it won't last. In both cases, investors often need help to stick to their long-term financial plans, regardless of the historical record. How can investors stay focused and invested in today's strong market environment?

The stock market has achieved several new all-time highs this year following last year's bull market recovery. The S&P 500 and Dow Jones Industrial Average are now 2.0% and 3.6% above their previous peaks from early 2022. 

While this is positive for investors, it's also natural to wonder whether markets have run too far or too fast. After all, it was less than a year ago when many investors and economists predicted a recession and worried about the rapid pace of Fed rate hikes. 

The market has achieved several new all-time highs this year

First, it's essential to understand that it is not unusual for the market to reach new highs during a bull market. By definition, bull markets spend much of their time at new record highs since markets trend upward over long periods. The accompanying chart shows how frequently these occur during market cycles. 

From 2013, when the S&P 500 recovered from the 2008 financial crisis to 2021, the average year experienced 38 days closing at new all-time highs, or roughly 15% of trading days. In years such as 2017 and 2021, we experienced many more. So, new all-time highs are not, on their own, reasons to be worried about the market or a signal that the market is about to reverse.

Second, what matters is not the market level but the business cycle and underlying macroeconomic trends. While there is still much uncertainty today due to inflation and the timing and size of Fed rate cuts, market sentiment has improved due to steady economic growth. 

This has driven rallies in technology-related sectors, including across the so-called Magnificent Seven stocks and in areas such as Industrials, Financials, and Health Care. 

In particular, the latest GDP report for the fourth quarter of 2023 showed that growth was stronger than expected at 3.3% quarter-over-quarter, exceeding economist expectations of only 2.0%. 

However, the GDP deflator (the statistic used to account for inflation in GDP) was only 2.6%, becoming the primary driver of how GDP blew past economist expectations. Considering Q4 headline CPI inflation was 3.24% and core CPI inflation was 3.99%, one must tilt and scratch one's head in an attempt to reconcile the 54% delta in the GDP deflator and reported inflation for the same period. 

Bonus chart here, courtesy of Hedgeye Risk Management

Questioning government statistics aside, the reported numbers mean that real GDP (adjusted for inflation) grew by 2.5% across all of 2023, one of the fastest growth rates over the past decade. Consumer spending, business investment, government spending, and trade all contributed to these results. 

The economy grew at a healthy pace in 2023

Finally, while it's natural for investors to feel they should wait for a market pullback before investing new cash or returning to the market, this can often backfire. The chart below measures the "opportunity cost" of being out of the market and waiting for a better price than simply staying invested.

For instance, waiting for a 3% pullback has required being out of the market for 69 days on average across history. Over that period, the market rose much more than 3%, resulting in a missed opportunity of a 2.3% gain. 

In other words, staying in the market the whole time would have been better. Waiting for a 5% pullback requires 291 days and results in a missed opportunity of 13.1%. Similarly, waiting for 10% market corrections or 20% bear market crashes can take years. In all cases, the peace of mind that comes from sticking to a plan rather than trying to time the market perfectly is an added benefit.

It's often better to stay invested than wait for a pullback

Unfortunately, doing so requires battling our tendency to see the glass as half-empty when markets are rallying. Of course, none of this is to say that the market only moves up in a straight line during bull markets. 

Investors should always be prepared for market swings and unexpected events, as the past few years have demonstrated. However, it's often better to avoid making rash decisions based on news headlines and the level of markets and focus instead on sticking to a well-constructed portfolio, ideally with the guidance of a trusted advisor. 

The bottom line: The market has achieved several new all-time highs this year due to steady economic growth. Investors should stay focused and invested and not make decisions based on the level of major market indices alone.

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Matt Faubion, CFP®

Founder - Wealth Manager

This article is for informational purposes only and is not a replacement for real-life advice, so make sure to consult your tax, legal, accounting, and financial professionals if you want more information. This content is developed from sources believed to be providing accurate information, and provided by Copyright (c) 2024 Faubion Wealth Management LLC. All rights reserved. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.