Often times we believe we have a good idea of how something should happen either because of previous experience or because of a set of supposedly supporting facts or because somebody we trust told us something would happen a certain way. Inevitably, expected outcomes don’t materialize. Some of us may spend considerable time contemplating why an outcome deviated from our expectations but most of us shrug our shoulders, attribute the unexpected outcome to fate or something along those lines and move on, failing to recognize that maybe our thought process was/is flawed or that we missed something important such as additional facts. It’s not uncommon to look for patterns in our lives and to base future expectations on previous experiences with particular patterns. However, there are so many variables to consider in a complex world that it’s extremely challenging, if not impossible, to account for all the relevant information that could impact an actual outcome and/or the timing of an actual outcome.
Let me give you an example. The stock market is once again near record highs after a recent minor correction. Various measures of the stock market’s valuation are at or near all-time highs. Earnings growth is slowing. While bond yields have picked up in the past week, they were dropping fairly precipitously before that (falling bond yields usually reflect concern). Some US economic indicators have been softening, suggesting the economy may be on its downward descent to the next recession. All of this information has led many to believe the stock market should be going down. After all, this pattern of information has been a fairly reliable indicator of stock market declines in the past. Additionally, “we’re due” for a recession and a major market correction, right?
Let’s take a closer look. Currently, nearly 62% of all stocks that trade on a US exchange are above their 200-day moving average. Nearly 65% of those same stocks are above their 50-day moving average. Additionally, the number of stocks advancing versus the number of stocks declining is once again in a noticeable uptrend after May’s and July’s swoons. Finally, most market participants are expecting easier monetary policy, which has been a major catalyst for stock performance over the past 10 years.
So while some of the “macro” data may suggest the stock market should decline from here, the “micro” data (market internals & expectations) are suggesting otherwise right now.
This is a good example of how we can get too caught up in what we think should happen versus what’s actually happening. It’s easy to see how one could have arrived at the conclusion that the stock market should go down. However, internal market data and participant expectations are telling a different story. This isn’t to say the market isn’t going to go down eventually. What it is saying is timing any inflection point is very difficult, and while we all need to pay close attention to warning signs, we have to be very careful not to overreact to those warning signs. In other words, we need to avoid being overconfident in what we think should happen versus what the data is currently telling us is happening. This is one of the reasons why a buy and hold strategy with a well diversified portfolio across asset classes, geographies and investment strategies is the most appropriate solution for most investors.