By: Steve Smith
It can be a fun parlor game trying to guess when a bull market might end, but it can be dangerous to your financial health. And I’m not even talking about those who try to call a top and begin shorting stocks even as prices keep rising.
No, I’m referring to investors who feel the market has come too far and feel they are being prudent by selling off their holdings. While no-one can argue with the concept “you never go broke taking a profit”, there is an opportunity cost of exiting a bull market prematurely.
This is because some of the greatest gains in the stock market occurred just before bull markets became bear markets. That is, the final innings of bull markets tend to rack up the most runs as sentiment moves towards the final euphoric stage.
Given the frequency of sustained multi-year bull markets tend to be few and far between, often punctuated with years of flat or even negative returns, it’s important for investors to reap all they can when they occur. And that means holding onto what can be the scary final stages.
“Equity returns in the last years of a bull market have historically been very strong, making it very painful to sell too early,” Bank of America Merrill Lynch’s Savita Subramanian said in a May 16th note to clients. This is a point she’s been telegraphing to clients for over a year
While it may be tempting to predict the market’s peak, almost every interpretation of the historical data shows this is a reliable way to miss out on gains, or even lose money.
Subramanian’s work shows the average return in just the six months before past market peaks was a whopping 16%. Over the 12 months and 24 months before peaks, average returns were 25% and 58%, respectively.
In other words, if you had sold too early, you would’ve missed out on above-average returns. While it can create anxiety to hold stocks as they continue to hit record highs, the prudent move is to wait until the upward trend is truly broken before exiting.
For those bears itching to sell, they will need to be incredibly patient as many of the market’s major warning signs will flash red for months or even years before things turn. The pain of shorting into the final push of bull markets maybe too great to stick around and prove you were “ultimately right, just early.”