Few things are scarier for smart investors than buying when stock markets are at all-time record highs. With the S&P 500 having soared to new records yesterday, sentiment among mainstream investors is unmistakably bullish. But subtler signs of nervousness have started to appear about the health of the economic recovery and the ability of the bull market to continue, raising fears that a stock market correction is imminent.
Ordinarily, investors can expect to see drops of 10% or more in the market roughly once a year, even in the context of an ongoing bull market. But the S&P 500 hasn't suffered a 10% pullback since December 2011. With such a long period having gone by without a stock market correction, does it make sense to hold off on buying stocks in hopes of getting lower prices? Or should you go ahead and buy, risking getting mauled by a big bearish move?
Are you ready for what you're wishing for? Whenever there are extreme market movements in either direction, emotion starts to play a huge role in investing decisions. Extended and uninterrupted stock-market rallies, as we've seen throughout the past two years, leave those on the sidelines feeling increasingly worried that they've missed out on huge potential gains. This pushes them to invest even as higher share prices make stocks less attractive from a valuation standpoint. In that light, waiting for a correction might seem like the smarter move.
Yet, waiting creates two more challenges. First, you have to have the patience to stick with your decisions, and that can be difficult if the bull market rages higher. For instance, at the beginning of 2013, markets soared after lawmakers averted the threat of a huge tax increase on the entire American public. Those gains led some to decide to wait for a pullback before getting in. They've been waiting ever since, and the S&P 500 is now 20% higher.
Second, once the correction comes, you have to have the conviction to follow through with your original commitment to buy. That's also a tough thing to do, because most stock market corrections hinge on some piece of exceptionally bad news that can make less secure investors question their entire investing plans.
Two smart moves to make now What makes the most sense is never to stop investing entirely, even as markets keep rising, but also to keep your eyes open for better prospects if a stock market correction occurs. That way, you'll benefit no matter which way the market moves.
When considering investments at near-record levels, it often pays to focus on areas of the market that most investors have neglected. Lately, consumer-staples stocks have gotten a huge amount of attention, with many investors turning to them for their reliable dividend income and defensive characteristics during pullbacks. Yet all the demand for dividend stocks has pushed their valuations up dramatically.