Are investors riding the wave of stock fund gains making a wise decision to stay invested in a bull market, or are they playing a dangerous game of chicken with an over-inflated market?
It may seem like a ridiculous question. After all, we’ve all had it hammered into our heads that the only way to build wealth is to buy stock index funds and hold them through all of the market’s ups and downs. Unfortunately, most of us don’t do this in reality.
The fund flow data shows billions of dollars moving among the various asset classes each month, and Morningstar’s studies have shown that investors — as a group — earn much lower returns in funds than the funds return themselves. This indicates an element of active decision-making that belies any notion of buy-and-hold.
It’s this kind of active approach that causes investors to get an itchy trigger finger when it seems like the market has gone too far, too fast. And it’s only reinforced by the various articles, comment threads, and message board threads screaming “Bubble!” at every turn. Unfortunately, anyone who has panicked and reduced their allocation to stocks in the past two years has cost themselves precious returns by missing out on the continued charge of the bull market.
So what’s an investor to do as the summer months approach? One answer is to keep an eye on the charts, since the broad market indices are in the midst of a long-term uptrend with a defined lower trendline. Above this line, investors can continue to own stocks without worrying about the onset of a bear market. Below it, it will be time to consider lightening up.
The chart of the S&P 500 provides clear reference points. On the two-year chart, the current trendline terminates at 1,860, which is 5% below Tuesday’s closing level. As long as the S&P can hold above this line, investors can remain confident that the continued storyline of steady growth, healthy corporate balance sheets, and low interest rates will keep the bull market intact.
S&P 500, Two-Year Chart
What happens if the S&P does break this trendline? A look back at a longer-term chart helps provide a sense of the various trendlines that are in place if the market indeed fail to hold its uptrend.
S&P 500, 5-Year Chart
It also pays to keep track of the Vanguard Total Stock Market ETF (VTI), since it incorporates the performance of both small- and midcap stocks. Here, again, we see a defined trendline that can be used as a guide of whether the uptrend has run out of steam. The current support line terminates at $97.24 — 4.5% below Tuesday’s close. Since VTI is slightly closer to its line than the S&P 500 due to the underperformance of smaller stocks earlier this year, it can be used as a source of advance warning.
VTI, 2-Year Chart
Keep in mind, these support lines are diagonal, meaning that the actual price level rises slightly each day.
This same approach can be used by investors in overseas stocks. The iShares MSCI EAFE ETF (EFA), which tracks the developed international markets, also has an established lower trendline that can be used to assess the current status of the bull market. Support currently sits at $66.05 — 6.0% beneath Tuesday’s close.
EFA. 2-Year Chart
Not everyone actively adjusts their fund allocations, but for those who do, these charts can provide a guide. As long as the trendlines hold, the bull market will continue, meaning no action is required. The time to worry will be upon us some day, but that time is not yet here.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.
