The S&P 500 (SNPINDEX: ^GSPC) has surged through 24 record highs in 2024 after going more than 500 trading days without a single one. Factors contributing those gains include anticipated interest rate cuts and excitement about artificial intelligence (AI), both of which promise to stimulate economic growth.
Indeed, Nvidia has become the quintessential AI stock, and it is responsible for about one-third of the gains in the S&P 500 year to date, according to Morningstar. Much like the chipmaker’s string of stellar financial reports, investors are apt to wonder how much longer the S&P 500 can maintain its momentum without a correction.
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Here are the two worst mistakes investors can make right now.
Mistake 1: Avoiding stocks in anticipation of a market correction
Anxiety is a natural reaction when the S&P 500 is bouncing between record highs, but avoiding the stock market for fear of a correction is a poor strategy. In a recent article, strategists at Fidelity Wealth Management explained that the S&P 500 has historically performed very well after notching a new high.
“Since 1950, in the year following an all-time high, average total returns for the S&P 500 index were 12.7%, compared to 12.4% for other 12-month periods. If you look back at each time the S&P 500 reached an all-time high, you can see that the market often pushed even higher, reaching new all-time highs thereafter.”
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Other Wall Street strategists have a similar outlook. Madison Faller and Matthew Landon at JPMorgan Chase wrote the following in a recent article:
“Over the last 50-odd years (going back to 1970), if you invested in the S&P 500 at an all-time high, your investment would have been higher a year later 70% of the time, with an average return of 9.4% — versus the 9% on average when investing at any time.”
Here’s the bottom line: While it may seem prudent to avoid the stock market at record highs, investors that attempt to time the market often get burned. Wall Street legend Peter Lynch said it best: “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
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Mistake 2: Ignoring valuations when buying stocks
Getting swept away by stock market momentum can be just as dangerous as avoiding the stock market altogether. Rather than anxiety, some investors become overconfident when the S&P 500 is bouncing between highs. They feel as though they can do no wrong because their portfolios keep getting bigger. But ignoring valuations to chase headlines is a recipe for disaster.
The sobering truth is the S&P 500 currently trades at 20.3 times forward earnings, a premium to the five-year average of 19.2 times forward earnings and the 10-year average of 17.8 times forward earnings. That means some stocks (or perhaps many stocks) are expensive by historical standards. Investors should be particularly cognizant of that fact when making decisions.
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No stock, no matter how good the underlying business, is worth buying at any price. Warren Buffett shared a similar opinion in his 1982 letter to Berkshire Hathaway shareholders. “A too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.”
There are many ways to value a stock. Some investors like ratios, while other prefer more complex approaches like discounted cash flow models. Either way, the goal is to determine whether a particular stock is trading above or below its intrinsic value. My advice to investors would be to avoid stocks trading at significant premiums to their average price-to-sales ratios or price-to-earnings ratios over the last two or three years, unless the business has undergone some significant change.
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