The stock market is due for a correction. It might not happen next week or next month, but the market is looking a little stretched right now. Investment risk remains high for taking on new positions.
If you pull up a long-term chart on the S&P 500 Index, one thing quickly jumps out at you. The Index looks like it’s slowly forming a large “head and shoulders” formation, with the right shoulder getting close to topping out. It’s an eerie-looking pattern that obviously may or may not take hold.
The stock market formed a similar type pattern from the late 60s to the end of the 70s. That was a decade-long head and shoulders formation that really didn’t see stock prices accelerate in a meaningful way until 1983.
If you believe in symmetry, the worry about the current trend in the S&P 500 Index is that the head and shoulders formation seems to be taking a very long time to develop. If you recall, stock prices rose tremendously from 1995 to 2000. The S&P 500 Index basically tripled during this period. Then, it all came apart and the market took another seven years to recover fully. After this recovery, we experienced the subprime mortgage meltdown that brought the stock market to its knees once again. The market is currently going through a slow recovery from the financial crisis and the outlook for stocks remains as unclear as ever.
It really brings home the point in my mind that the stock market is a system that acts irrationally and is very adept at punishing investors whose timing is wrong. All the ads for mutual funds say that it’s impossible to time the market, so why bother? But, timing the market is precisely the most important determinant in generating suitable returns to compensate you for the risk inherent in the stock market.
This also brings home the point of equity investing. Speculating in equities consists of trading the market for near-term capital gains. Investing in equities consists of picking reasonably valued stocks with underlying businesses that can consistently grow their earnings. Both strategies are valid and have their pros and cons. For the investor with a longer time horizon for investment, dividend payments play the critical role. Without dividends, passive investors would have lost money over the last 12 years.
So, it turns out that good timing is absolutely critical to your investing strategy. This requires a lot of patience on the part of the investor. Waiting and watching for only the best investment opportunities to come across your desk is a serious exercise in discipline. For my money, I like the buy-low-and-sell-high investment strategy. Right now, this investing philosophy looks much better suited to buying real estate over stocks