Tuesday, May 4, 2010

Do Stocks Only Go Up?

For the past 10 or 11 weeks it seems like Canadian and US stocks have gone up every day. There have been a few down days, but the rise has been quite steady. Even though I know better, I expect to see another increase when checking each day.

If this trend continues long enough, many investors scared off by the market lows from a little over a year ago will be lured back in. Even higher stock prices would lure in people who have never invested in stocks before.

Few of us are immune to the perverse tendency to be wary when stock prices are low and confident when they are high. Perhaps we can expect the deluge of reports about reducing risk by reducing stock ownership to reverse and we’ll see more commentators talking about the merits of long-term stock ownership.

I find I can never remind myself too often about Warren Buffett’s advice to “be fearful when others are greedy and greedy when others are fearful.” So, instead of going out and spending as though you expect stocks to continue their steady climb, make plans that include the possibility of another big drop in stock prices.

8 comments:

  1. I've been watching the P/E of the S&P500 climb steadily back over 20 with some trepidation. The trouble right now is, if you're worried about stocks, where do you put your money? With interest rates as low as they are, there's not much of an alternative right now.

    Maybe those preferreds of yours aren't looking so bad after all...

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  2. @Patrick: I'm trying to stop playing the game of guessing where to put my money. I've chosen a stock allocation (mostly in broad ETFs) and am planning to just rebalance.

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  3. Good advice.

    Now how do you get people to pay attention to it? It's just against human nature.

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  4. @Mark: That's definitely a challenge. The way I see it, it's impossible for me to get everyone to pay attention or even all the people who read this blog. But if I can get just a few people to think more rationally about investing, I'm happy.

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  5. I always wait to see mailers from IA's I don't know telling me to buy. At that point, I know the bandwagon is heading towards an unhappy ending.

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  6. @Thicken: That's one of the more amusing rules of thumb I've heard for trying to detect stock bubbles.

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  7. A timely post as the market seems to have hit an air pocket this morning. I like your allocate and rebalance approach. I don't think that "there's nothing better to invest in" is a good reason to boost your equity allocation. I would still rather gain zero than lose anything.

    Until global leverage levels come down, I maintain that the market is riskier and more volatile than usual. Anyone with a shorter investment horizon should be careful about keeping a higher equity allocation. Look at a chart of the Nikkei. If the U.S. takes a Japanese turn, equity returns will be poor and may not recover in time for retirement.

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  8. Hi Michael. Point taken with regards to sticking with an asset allocation. I guess I was making the far weaker point that if one believes the P/E of stocks is too high, the trouble now is that the P/E of bonds is also really high, so it's hard to use that as any kind of guide.

    You're left with looking at other ways to drive your investment decisions, and one sensible way is to stick with the same asset allocation you've already decided on.

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