Figure 1 shows the distribution of S&P 500 forward 12-month price returns from days when the index hit all-time highs and all other trading days from 1928 through April 30, 2021 partitioned by stage of economic expansion. Early cycle and late cycle refer to the first and second half of expansions, characterized as periods between NBER designated recessions. Right side shows the performance distribution for all observations. Sources: National Bureau of Economic Research, WTIA, Macrobond.
Forward return results will vary for time periods other than 12-months.
Past performance cannot guarantee future results. Indexes are not available for direct investment. Investment in a security or strategy designed to replicate the performance of an index will incur expenses such as management fees and transaction costs which will reduce returns.
Early cycle tailwinds
The question of whether to invest at all-time highs is a bit more nuanced when the economic cycle is in its final innings, and the risk of an approaching recession is a more immediate concern. However, we find ourselves in a much different predicament today, having recently turned the page on the COVID-19 recession and as a new economic cycle commences. To incorporate the current early-cycle dynamics, we took our analysis above one step further to examine whether the range of performance outcomes of investing at new highs has varied at different stages of economic expansions. After splitting all market cycles in two, we found that investing at all-time highs has indeed yielded better outcomes in the first half of the expansion (Figure 1), with a median return of 11.7% over the next 12-months versus 4.6% in the second half. The first half also brought a more significant positive skew, with positive returns observed 87% of the time versus 58% in the second half.
The results reflect how the probability of the worst possible outcome, an economic recession, is far lower in a business cycle’s early stages. Those hesitant to invest at this time may want to consider that contrary to a mature expansion, when growth is typically slowing and policy is tightening, the global economy is currently on the rebound, policy is highly accommodative, and we expect to see the highest GDP growth in several decades in 2021. Although the near-term path forward remains uncertain, one thing we can say with a fair amount of confidence is that the early stages of the cycle have historically provided the most favorable backdrop for equities, and investors with a long time horizon are better off getting involved right away rather than waiting.
The opportunity cost of waiting for a pullback can be substantial
With any major purchase in life, whether it be a new car, home, or flat-screen TV, there is a sense of comfort that comes with locking in a bargain. For equity investing it is no different, and the past year has shown that a bear market decline can unveil the buying opportunity of a lifetime. An investment in the S&P 500 on March 23, 2020, the trough of the pandemic-induced selloff, would have reaped an eye-popping gain of over 90% through the current week. With recent proof that a well-timed, opportunistic purchase after a steep market drop can generate an immense windfall, why not just wait for another pullback to deploy fresh funds?
The issue with waiting for another comparable homerun opportunity is that bear markets are relatively rare. There have only been 12 market declines of over 20% since 1945. Even 5% drawdowns aren’t particularly frequent. As shown in Figure 2, S&P 500 all-time highs have outnumbered pullbacks of 5% or more by 10-to-1 over the same period, and hence waiting for a 5–10% decline brings the risk of missing out on significant upside in the interim. The last several months have delivered an excellent example of the opportunity cost of waiting. The S&P 500 hasn’t recorded a 5% drawdown in roughly 130 trading days (October 26), a period in which the index hit 36 all-time highs. An investor waiting on the sidelines would have regrettably missed out on a 24% gain over that span.
Figure 2: S&P 500 total all-time highs and pullbacks of 5% or more since 1945