Does It Matter That the Markets Are at an All-Time High?

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

This past week, the Dow Jones Industrial Average (^DJI 0.45%) again set multiple all-time highs during the week and managed to finish Friday above the 16,000 mark, climbing to a record 16,064. The S&P 500 (^GSPC 0.02%) also hit a few all-time highs last week, and broke above the 1,800 barrier while closing on Friday at 1,804.

But does it matter that the major indexes are hitting all-time highs? And not just once, but multiple times nearly every week?

Well, I don't think there's a clean-cut answer to that question. When we think about a stock hitting a new all-time high, what does that mean? To me, it doesn't mean a whole lot other than if I own it, it's never been worth more than on that day. But we often see stocks pushing higher and higher, setting new record highs, and while the media may mention it, they don't blow it out of proportion.

As the major indexes hit new highs, it's essentially the same thing, despite all the media hype. If you own an index fund, then great, that asset has never been worth more. But just because an index or stock is hitting new highs, that doesn't mean it's bound for a crash or correction.

Stock prices, and therefore index values, are based on company earnings, as well as on what those earnings are expected to be in the future. So if earnings are expected to increase from where they are today, then a stock price will increase, and if enough individual stocks rise, the indexes rise, too. If a stock or index sits at a new all-time high, it would simply imply that investors have never expected profits to be as high as they currently believe they will be.

Increasing profits are a normal thing. The world population is constantly growing, and innovations and new developments are regularly unfolding around us. Thus, business revenue and profits should, and normally do, also regularly move higher. And so stock prices will consistently increase over time despite the occasional crash, pullback, or recession when earnings slow down, thus causing stocks to fall.

Since this is the nature of stocks, regularly hitting new highs should be expected, not feared that it's a sign of an imminent market crash. Consider the number the Dow now sits at: 16,064. Has the market fallen backwards that many points without regaining those losses? Has the market crashed that many times? No, and no.

A new high for a stock or an index doesn't mean doom and gloom is right around the corner. But even if it did, based on what we know about the market and how it has recovered from the financial crisis or even the dot-com bubble on an un-inflation-adjusted basis, an investor would be better off riding out the downturn, knowing that sunnier days lie ahead.