Market highs: Cheer, but not too loudly

Market highs are exciting, but don't get carried away

a woman

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Did you hear? The Dow Jones Industrial Average and US S&P 500 index have hit fresh highs. Break out the bubbly (Dom Perignon, naturally).

Janet Yellen isn't rocking the boat, rates are staying 'lower for longer' and the punch bowl is a never-ending magic pudding, if you'll excuse the mixed metaphors. The music is playing and the market is dancing up a storm.

Of course, if 'lower for longer' rings a faint bell, it'll be because you're recalling 'stronger for longer' — the favourite three word slogan of the mining perma-bulls. This boom will go for years, they said — don't worry about falling mining employment, collapsing mining services companies or a plummeting iron ore price that's already put some marginal miners out of business and is threatening others.

Avoid three word slogans

Three word slogans might be clever electioneering, but it turns out 'stronger for longer' was really 'get out now while the getting is good'. Not that you'll find many of those perma-bulls prepared to put up their hands and admit they were wrong, of course.

Far from wanting to rub salt into the wounds, my point is that 'stronger for longer' never really is. Not in a stockmarket sense anyway. Put up against Sir John Templeton's famous line that "the four most dangerous words in investing are 'this time it's different'", Templeton wins by a knockout. When a market works properly, higher prices attract more competition, which results in lower prices. Iron ore bulls, like gold bulls before them, forgot that simple economic lesson.

But back to the overnight Wall Street highs. It's hard — and a little churlish — to begrudge investors their celebrations… after all, the GFC left a financial scar (and a much larger emotional scar) that many still carry today. Those who lived through the stomach-churning tumult of 2008 and 2009 are entitled to be using recent highs as a salve for those wounds.

The European economy no longer looks to be the 'anytime soon' cause of a global meltdown, and China's woes don't appear — yet, at least — likely to preempt a worldwide malaise. The US is well and truly down the path of its two-steps-forward-one-step-back recovery, and while that country's policymakers are still pursuing 'emergency levels' responses, the end of those drastic measures is within sight.

'What's been' doesn't count… look for 'what's to be'

But here's the thing to remember about stockmarkets. They are forward-looking mechanisms. Investors are putting money on the table today to take advantage of events they foresee next month, next year and beyond. Of course, as the iron ore story tells, markets don't always get it right, but that's the broad reality.

So when you see all-time highs, you're entitled to enjoy a little bit of a warm inner glow. After all, who doesn't like more money? But when the feeling has passed, don't forget to remind yourself that investors were enjoying all-time highs in 2007, too… just before the GFC hit.

A peak doesn't always presage a fall. And the stockmarket is characterised by over a century of higher highs. Betting against human ingenuity and the profit motive is a dangerous pursuit. Indeed, higher highs come specifically because companies find ways to innovate, grow and prosper. And if it's higher earnings that are propelling the market higher, the ground is far more likely to be solid than if investor optimism is behind the drive.

It's likely that the ASX is somewhere in between. The data suggests that investors are certainly more optimistic that in the past — as defined by rising price/earnings multiples. But at the same time, some of that optimism is being proven out by higher profits, especially in certain sectors. That's in some senses self-propagating — higher profits lead to greater optimism — so it's worth keeping a level head.

Scott Phillips is a Motley Fool investment advisor. You can follow Scott on Twitter @TMFGilla. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691)

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