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The Smart Money Is Buying All-Time Highs - And Why You Should Too

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It is one of the great paradoxes of the stock market that what seems too high usually goes higher and what seems too low usually goes lower.” – William O’Neil

It’s been a solid start to the New Year for investors, with all three major U.S. indices well in positive territory for the month of January. We’re heading into the final trading week with the S&P 500 advancing 2.54%, the Nasdaq gaining 2.96%, while the Dow is up 1.11% as of this past Friday’s close.

The multi-month rally off the 2023 October lows has yet to run its course. Both the S&P 500 and Dow Jones Industrial Average notched new all-time highs last week. The Nasdaq hasn’t yet eclipsed its former high, but remains less than 4% away from the pivotal level.

There’s something about buying at record highs that just doesn’t sit well with most investors. Behavioral biases lead them to believe that they can likely buy at cheaper prices in the future. But as we’ll see, new highs have historically been a great time to purchase stocks. And while we certainly can’t guarantee that will be the case this time around, there’s plenty of reasons to suspect we’re in the early innings of a new bull market.

Bull Markets Last Longer Than Bear Markets

It took more than two years for the S&P 500 (SPY - Free Report) to eclipse the highs from January 2022. New highs should be viewed as a sign of strength; it means that stocks are ultimately surpassing levels that met former resistance, and a breakthrough of those levels normally ushers in additional buying pressure.

Image Source: StockCharts

We’re starting to see this now as volume was above-average over the past week, a good sign that the momentum can be sustained. As a general rule, volume flow usually precedes price movement.

Dating back to the 1950s, once those former highs were put in the rearview mirror, bull markets have lasted an average of another 4.5 years. This overlooked fact suggests the potential for more gains ahead that could be substantial. Investors normally underestimate the length and magnitude of bull markets.

In the past, when we’ve eclipsed a new high in the S&P 500 after at least one year (it was more than 2 years this time around), the index performance a year later averages a +14% return and has been higher 93% of the time:

Zacks Investment Research
Image Source: Zacks Investment Research

Economic Data Surprises to the Upside

A preliminary estimate of fourth-quarter GDP (released last week) showed that the economy grew at an annualized pace of 3.3% during the period, much faster than the median 2% projection. It’s another data point that suggests consumers ended the year on a strong note. Consumer spending expanded at a 2.8% annual rate; remember, consumer spending accounts for about 70% of U.S. GDP.

Despite the impressive Q4 GDP growth, inflation remained tame. The Fed’s primary inflation gauge (core PCE) rose at a 2% annual rate in the fourth quarter, matching expectations. Markets are expecting rate cuts this year, and the decelerating inflation trend is providing the Fed with ammunition to do just that.

Investors tend to associate rate cuts with a weak outlook and future problems with the economy, but once again, history shows that rate cuts have been good for stocks on average. In the span of over a century, the Dow has rallied an average of 14.4% over the next 12 months following the first rate cut. Perhaps this time around, the economy is on sound footing and the Fed believes the worst of the inflation issue is behind us.

The Fed will conduct its first policy meeting of the year on Tuesday and Wednesday of this week. They’ll hold rates steady (markets are currently pricing in a 98% probability), but a March rate cut is more likely (48%).

Positive Seasonality Supportive of Stocks

We remain the midst of the best 6-month stretch from a seasonality perspective that spans from November through April. This year is also an election year, which is the 2nd best year of the Presidential Cycle. Stocks typically do well in election years, particularly under new Presidents. The S&P 500 has averaged a 12.2% return during election years when a new President has been in office:

Zacks Investment Research
Image Source: Zacks Investment Research

Presidential incumbency is an influential phenomenon and considered to be a driving force behind the 4-year Presidential Election Cycle. Dating back to 1950, the S&P 500 is up more than 12% on average in election years when a sitting President is running for re-election, versus about 7% in all election years. When there is an open field (meaning years with no incumbent running for a second term), the S&P 500 has averaged a -1.5% loss.

Adding to the bullish case, in cycles where we’ve experienced negative midterm years (as was the case in 2022), we’ve never had a lower election year since 1950. When midterm years are negative, election years rise 13.2% on average and tend to follow strong pre-election years (which did occur last year).

Bottom Line

Investors would do well to fight the natural wariness of buying new highs, as history shows this is an excellent time to purchase stocks. Backed by a resilient economy and positive seasonality, a new bull market is underway with the potential for significant advancement in the coming months and years.

The Q4 earnings season continues to heat up with some major companies reporting this week including tech titans Apple, Microsoft, Facebook-parent Meta Platforms, Google-parent Alphabet, and Amazon. Make sure you’re taking full advantage of all that Zacks has to offer as we wrap up the first month of the New Year.

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