“Markets around the world are hitting record highs, Steve… I’m worried they can’t possibly go any higher.”
I’ve been hearing this for years. And I get it.
Stocks have been going up for years. And we’re near new highs around the globe right now…
U.S. stocks just hit a record high last week. U.K. stocks hit new highs within the last month… German stocks too. Japanese stocks haven’t hit a record high, but they hit a 17-month high recently (which is still impressive).
[ad#Google Adsense 336×280-IA]It’s not just these markets… All around the world, stocks are soaring.
As soon as any market hits a new high, investors get worried… They think it can’t go higher.
But this is dead wrong, as I’ll show you today.
These new highs are great to see in the short term – though potentially problematic in the long term.
Let me explain…
From an emotional perspective, I understand why people worry about new highs. But I also know what the math looks like…
The numbers tell a very different truth than you might expect.
I looked at the major world stock markets going back to the 1960s. (That’s half a century of data for each country.)
Specifically, I wanted to find out what happened to stock markets after they hit new 12-month highs.
The table below shows what happened to the markets one year after they hit new 12-month highs, versus new 12-month lows.
The conclusion is simple: Stocks perform fantastically a year after hitting a new 12-month high. And they perform terribly in the year after a 12-month low.
In short, markets perform well after new highs, and poorly after new lows.
Last week, many markets hit new 12-month highs. This is actually a good sign looking one year ahead – not a bad one.
But how long will it last?
If you think markets have to fall back to Earth eventually, you’re right.
The market does fall… at some point. It just doesn’t happen as quickly as most people expect.
We’ve already looked at what happens one year after a market hits a new high or low. Now let’s take a look at what happens in the long run…
Here’s a table of the annualized returns of stocks five years after a new 12-month high or low.
After stocks hit a 12-month high, they tend to underperform their typical returns for the next five years. (Japan seems to be an exception to the rule.)
The opposite is true as well… After stocks hit a 12-month low, they outperform their typical returns for the next five years.
So what can we take away from these two tables?
1. In the short run (one year or less), markets really do keep going up after hitting new highs.
2. In the long run (around five years), markets do “fall back to Earth” after hitting new highs.
Said another way:
1. The trend works in the short run.
2. Mean reversion works in the long run.
Most people don’t want to hear this… They seem predisposed to only believe in one of those two things.
But it is true across nearly all asset classes.
So, here’s what we can take away from this today: Based on history, stocks around the globe should continue higher in the next year. And in the next five years, they should underperform.
This also fits with my basic thesis: “Melt Up, then Melt Down.”
I believe stocks can move much higher over the next 12 to 18 months… before finally falling lower as the extremes revert back to normal.
For now, that means we want to stay long stocks.
Good investing,
Steve
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Source: Daily Wealth