Stock Indexes Set New Highs: What Now?

Summer is supposed to be the dead time for stocks, the doldrums. Everyone is on vacation, the theory goes, so nobody is around to buy.

It’s an actual theory, captured in the trader phrases “Sell in May and go away” and what’s known as the “Halloween indicator.” Essentially, the argument goes, it’s best to get out of stocks before summer starts and then get back in before winter, on or about Oct. 31.

The data suggests that’s generally true — except when it’s not. The stock indexes are now setting record highs in mid-August, typically a treacherous month for active traders trying to time their market entries and exits.

So what does all this mean for the retirement investor? That exceptions are exceptions and that’s all. Here are some of the “reasons” that managers think stocks are hitting new highs:

• The U.S. is growing the rest of the world is not
• Earnings are strong, as well as stock buybacks and dividend yields
• Oil is unpredictable, gold is unpredictable, bonds are unpredictable — so buy stocks
• Team USA is cleaning up in Rio

And so on. While these are all “reasons,” they don’t mean much. That the stock market keeps rising despite the risks inherent in the economy is, ultimately, a circular argument.

Buy stocks, they’re going up. They’re going up, so buy stocks.

The flip side of this argument is equally circular. It’s not hard to find doomsayers who consistently predict a stock market crash.

The stock indexes are too high, they claim. They have to fall, so you should sell everything. So people sell, get scared, and sell more. Stocks fall more.

The reality of investing is between these two opposing forces. Yes, it matters that companies are making more money. It matters that other investments seem risky in comparison.

It even matters that investors are in a good mood about the country. Olympic wins don’t hurt that perception.

And that’s how a pattern such as the Halloween indicator is disproved in any given year while seeming reliable over the long haul. Emotions get us into trouble, to the upside and the down side.

The answer is to ignore all of these “factors” that traders use to reach their conclusions. It’s far too easy to ascribe meaning to randomness, to find a reason why the trend you think you see reflects reality.

Winning with stock indexes

Behavioral scientists have long marveled at our human ability to find patterns in randomness. People see religious figures in swirls of toast. Amateur astronomers spot people walking on Mars.

It’s called “apophenia,” and arguably it served some evolutionary purpose over eons, perhaps to spot camouflaged predators in the bush and flee. Better to run from nothing and survive than to hold still and be lunch, right?

Yet seeing patterns in stock indexes can be very dangerous. We tend to pile on in rising markets, buying at ever higher prices. Then we hold on to falling markets and bail out only when the news is the worst. Buy high and sell low. Guaranteed losses.

The solution is portfolio investing. You own a collection of assets and rebalance. You force yourself to sell a portion of your winning investments and use that money to buy into the temporarily losing investments.

You do this over and over, regardless of the news headlines, who’s winning gold medals, the time of year or patterns you think you see in the numbers. That’s how long-term investing should work, and it can work with a discipline and a solid plan.