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Does It Make Sense to Invest in Stocks When They’re at Record Highs?

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82% of the stocks in the S&P 500 are trading above their respective 200-day moving average, our research shows that’s a potential harbinger of the equity market producing excess returns over the Bloomberg Barclays Aggregate Bond Index.

The dog days of summer are turning out to be anything but sleepy in the stock market. Of August’s 12 trading sessions, eight of them have produced record closing highs for the S&P 500.

That comes amid rising macroeconomic uncertainty, including rising Covid cases, reports of busy hospitals, a plunge in consumer confidence in the monthly University of Michigan survey, China’s regulatory crackdown, and the Taliban’s resurgence in Afghanistan.

Does it still make sense to overweight stocks given the cloudy conditions? Horizon Investments looked at whether the broad participation of companies in the current rally – 82% of S&P 500 stocks are trading above their 200-day moving average – has any predictive value?

What we found was that, since 2015 when breadth was at its current level, the S&P 500 produced a median excess return of 2.5% versus the Bloomberg Barclays Aggregate Bond Index over the next 20 trading sessions. So long as the breadth figure remains near current levels, history would suggest that stocks should produce superior returns over bonds in the near-term.

Investors, understandably, can feel nervous about sticking with stocks at all-time highs, especially if their financial goal is coming into view. For a client in that situation, financial advisors may want to assess if their client’s risk profile is shifting to being more worried about a catastrophic loss.

If that is determined to be the overriding risk, then that client has entered what Horizon calls the Protect stage and is no longer in Gain, where volatility is the primary risk. Horizon Investments believes that an investor’s fundamental risk changes as they enter a new stage of their financial journey (read our Redefining Risk paper to understand our goals-based investing philosophy.)

For goals-based investors who still want to accumulate wealth, yet are nervous with equities at all-time highs, they may want to consider Horizon’s Risk Assist® strategy. It is designed to keep a client fully exposed to markets while conditions are normal. However, if conditions severely deteriorate, the Risk Assist® algorithm uses a disciplined, systematic process to dynamically “de-risk” the portfolio with the aim of achieving a specific loss tolerance range. As conditions improve, the algorithm uses the same process to “re-invest.”

The Risk Assist® strategy also includes a “ratcheting” feature, which raises the loss tolerance threshold as the portfolio value grows, typically with every 3%-5% of appreciation. For each ratchet, Horizon sent advisors a real-time alert.

 

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1 Bureau of Labor Statistics, https://www.bls.gov/news.release/archives/empsit_07022021.htm
2 Vanguard, https://institutional.vanguard.com/content/dam/inst/vanguard-has/insights-pdfs/21_CIR_HAS21_HAS_FSreport.pdf
3 Society of Actuaries, 2020

 

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