Let’s take a brief trip down memory lane (six weeks ago), if only to illustrate the seductive powers of past performance.
Six weeks ago, after two months of horrific market declines, everyone was all-but-certain that DOW 6,000 was in the bag. The S&P 500 was going to 600. The economy was going to hell in a handbasket. All day long, CNBC guests talked about the benefits of sitting on the sidelines and keeping money in cash.
Six weeks later, the economy is still going to hell in a handbasket, but the S&P 500 is up almost 25%, the DOW’s up 20%, and oil’s climbing again. CNBC guests are now talking cheerily about the second-half recovery. Most of the people who panicked on the way down are still sitting on the sidelines, but they’re getting more comfortable as the market climbs.
Another 10%-15% rise, and everyone will begin to worry about missing the next big bull market (which, if it has started, they will already have missed a big chunk of). And then, when everyone agrees that the worst bear market since the 1930s is over, the folks on the sidelines will pull the trigger. At which point, we will have set ourselves up nicely for the next leg of the bear-market decline.
But that last part is only our opinion. It’s possible that the consensus optimists are right and that we are in the first leg of the next great bull market. Which is why, for long-term investors, it’s smart to ignore news and sentiment and add to equity positions when stocks fell below fair value, as they did in those dark days of November: Because you never know what happens.
One thing we do know: The more the market rises, the more optimistic and confident everyone will get. Just don’t confuse that warm, comfortable feeling with safety. Expected long-term equity returns are considerably lower now than they were at the end of November. The more the market rises, the lower those returns will become, and the less safe the market will get.