Why has the U.S. Stock market been doing so well recently?
The current "bull run" began in early 1995. after no gains in 1994, Indices measuring theperformance of the stocks (sometimes called equities) of major corporations increased about 35percent in 1995, and around 25 percent in 1996. So far in 1997, these same indices are already upover 25 percent. There are several reasons for the booming stock market. First, continued goodeconomic news. Some economic analysts have called this a "Goldilocks" economy--not too warm,not too cold, but just right. Both inflation and unemployment are low, but corporate profits arestrong and rising. In part because of the expanding economy, the federal budget deficit is rapidlyclosing. Finally, the post-war baby boomers--many now moving into their 50s--are increasinglyconcerned about building a financial nest egg for retirement, and see the equities market as the bestway for doing that. This further fuels demand for stocks.Can this continue? Stock market investors cannot hope for a 25+% return every year, can they?
If we look at longer term trends, say ten years back, the average has been more like 15 percent peryear, but with wider year-to-year swings than we have seen recently. Another ten years back, andthe average has been around 10-12 percent, but also with a number of years in which overall averagereturns from investing in equities were negative. Most economists expect a downturn in the growthof the economy some time in the not too distant future leading to a more protracted downturn in thestock market than downturns we have seen in recent years. Recent sell offs have lasted only a fewmonths--the most recent one occurred this spring. The major worry right now is that the rate ofcorporate profit growth required to sustain a market where stock prices are rising at a 25 percentannual rate is unsustainable in the longer term. Once corporate profit growth starts tapering off, stockprices will soon head downward. Predicting when this slowdown will occur is quite another matter.History illustrates some of the problems in forecasting the short-term movements of stock prices. Based on what happened in 1994, prognosticators then were forecasting a weak year for stocks in1995. But stock prices soared in 1995--arguably, the best year in history. A number of major moneymanagers made switches out of equities into government bonds in early 1996--fearing high stockprices and a market sell off. But 1996 was again a strong year for most of the market. And manymoney managers became really concerned at the start of 1997, fearing that the Federal ReserveBoard would increase interest rates, resulting in both a stock and bond market crash. Thesemanagers moved investment money into cash, and the market did drop for a short time in the springof '97. If these professionals--those who do this work for a living-- were fooled by the course of theeconomy, the average investor is not going to do any better in attempting to "time" the market.There is no shortage of commentators and analysts willing to forecast a serious market downturn inthe near future: these guys are so good they have predicted nine of the last two sell offs. Meanwhile,the investor who believes these forecasts and sells stock investments forgoes profits that could havebeen made if the money had remained in the market.
Is now the time to be buying stocks, or should I be selling them?
There is a simple and wise long term strategy, embodying three elements:(1) Never invest money in the U.S. Equities market that you expect to need in less than 5 years.Choose less risky money market funds or bank certificates of deposit for shorter-term investing.
(2) Make sure the equity investments you choose are broadly diversified. Investing in a single stockis inherently risky: buying a mutual fund share of a diversified portfolio of many different stocks ismuch less risky. The popularity of the so called "market index" mutual funds relates to the fact thatsince these funds invest in a stock portfolio that mimics the overall performance of the market, theyare by definition very diversified. Further, in recent years returns from this approach has done aswell or better than most of the well-known actively-managed equity funds--a simple market indexfund beats 95 % of active managers so far in 1997 (and also may be cheaper for the investor withrespect to taxes on gains made each year).
(3) Establish a regular plan for investing in the equities market with a fixed dollar amount eachmonth or quarter, and don't worry about where the market goes from one day (or week) to the next.Simply keep adding to your investment on a regular schedule regardless of what is happening on aday-to-day or month-to-month basis. Despite short term fluctuations in the stock market, U.S.equities represent ideal investments for the long term. They are especially well suited for investmentswhere the money is not needed for ten years or more--ideally for building funds for retirement orthe childrens' college expenses.
Performance of the S&P 500 Index Representing Stocks of 500 of the Largest US-Based Corporations Over the Past 10 Years
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