Trying to correctly time the market is a near-impossibility for any investor, and the potential mistakes are just as severe whether you’re trying to sell high while you can, or buy low.
Because of this, investors who are concerned about the current state of the U.S. stock market may want to take a long-term view and hold tight to their positions.
According to data from the Wells Fargo Investment Institute, the final year of a bull market can be one of the best of the economic cycle for investors, and staging an early exit from stocks to avoid a coming downturn can be a costly long-term mistake.
Equities tend to see steep gains in the 12 months before the start of a bear market, the data showed. Large-cap U.S. stocks rise an average of 24.2% in the 12 months before the start of a bear market, while small-cap equities jump an average of 36.4%, historically.
A bear market is typically defined as a 20% drop from a market peak, or twice as severe as threshold for a correction, which is a 10% drop. Currently, both the Dow and the S&P 500 have seen their longest stretch in correction territory since the financial crisis.
Last-year rallies are sometimes referred to as a “melt-up,” or a move higher that is driven by investors being fearful of missing out on past gains. Some analysts have been forecasting a melt-up on Wall Street for months.
The gains in the last year of a bull market make for a much more pronounced rally than is seen earlier in the cycle. The penultimate year of a bull market sees a 14.4% gain for large-cap stocks and a 13.7% rally for small companies. In the year before that—meaning the period that is between 36 and 24 months before the start of the bear market—large stocks gain 14.2% and small stocks rise 18.5%, as seen in the following table.
“Our research shows that the final stages of a bull market can be lucrative for investors and an early exit can be detrimental to an investor’s long-term returns,” the Wells Fargo Investment Institute wrote in a note to clients. “In our view, investors should consider maintaining full equity exposure because the final years of bull markets historically have been strong. We believe U.S. economic data supports the case for continued economic recovery and further stock market gains.”
Thus far this year, the S&P 500 SPX, -0.23% has lost 1.7%, though it rose 19.4% over the course of 2017. The Dow Jones Industrial Average DJIA, +0.02% is off 3.2% thus far in 2018, but it gained 25.1% last year. The Nasdaq Composite Index COMP, -0.18% gained 28.2% over 2017, and it has extended that upward move thus far this year, up 2.8% in 2018.
Concerns that the market could be looking at weak future results—if not necessarily a bear market—have been growing. Morgan Stanley recently calculated that expectations for stock returns are at their lowest point since before the financial crisis.
Among the headwinds cited by investors are uncertainties surrounding trade policy and geopolitical tensions with North Korea and other regions. Furthermore, changing monetary policies by the Federal Reserve are widely seen as a potential risk, leading investors to abandon their recent habit of buying market declines.
On the other hand, stocks aren’t seen as overly expensive right now, and the first-quarter earnings season has been extremely strong, although the market reaction to them suggests investors haven’t been impressed.
Despite what happens over the coming years, however, most analysts agree that the best course for most investors is to stay put, getting the benefit of compound interest and not making short-term trading decisions.