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Breaking News: Stock Markets Can Go Up

A lot of people are talking about the dangers of investing in the stock market now that it has risen so much in recent years. There are a few flaws in these arguments but one of the interesting things is that the true reason behind them is the same one that drove investors to be very aggressive in 1999 and 2006.

If you go back 10 – 15 years, many investors had seen a very long and seemingly unstoppable bull market for stocks starting in the early 80s. There were a few crashes, but what they learned was that these were great buying opportunities because the market always came back fast and reached new highs. They had completely forgotten the multi-decade bear markets earlier in the last century. As a result, if the market was going up they thought it would go up further and if it was going down they thought it would turn around soon.

This rush of confidence led to a peak in 2000 and again in 2007. Finally the news 5 years ago was enough to break investor confidence and they really sent the markets down. But now we’re seeing the same logic play out with a different reference point.

Many investors can look back and see that the stock market hasn’t increased by much since 2000. Many indexes have barely passed their levels at that time. If you account for inflation the picture looks even worse; the peak S&P 500 value 13 years ago would be around $2000 today. So investors have learned that stock markets don’t really go up and if they do they will probably crash again soon. We are forgetting the times when the market has done well.

Despite the large gains we’ve already seen this year, this seems to still be the dominant mindset among investors. In 1999 it was easy to think that the stock market goes up a lot, and hard to believe that it should come down at such an exciting time. Now it’s easy to think that the stock market never really advances in such a dangerous time.

We need to remember that since it tends to have an increasing value over time, there is nothing particularly dangerous about reaching new highs. This should happen regularly. And prices that were once normal eventually become so low that we will never see them again.

It’s entirely possible for the market to set a record high and then never fall below that level again. It’s possible for the market to rise a lot, and then rise some more. The rate of return may decline for a bit after a large jump, but if the fundamentals have gotten ahead of the prices then it’s still a safe market. The highest price we’ve ever seen might also be the start of a bull market.

For example in early 1985 the S&P 500 reached a price of $177. It had never been that high before and was never that low again apart from a few days later in that year. And this was only two and a half years into the recovery from a long bear market that had seen a closing price in 1982 that was 7% below the price from 9 years prior. Over the next 15 years it reached many new highs only to keep going higher.

I also believe that a correction or a crash is possible. I would welcome that. As much as people say that the market is overpriced, I believe they would be even more afraid if it did crash again. This would just confirm their fears. They are more likely to buy in if it keeps rising and they see others making money.

With so many people still being scared of the stock market, I wonder how much further it has to rise before they believe that it is safe again. And I wonder how much higher they will push it once they do change their minds. If that’s what plays out it will be very expensive for investors who thought they were being cautious.

Ironically the level of fear these days in the media and on blogs sounds a lot like what everyone was saying in 2009. It’s a hard time to invest in stocks. But it just might be a good time.

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