Sometimes you just have to take a step back and stare in awe at the stock market. Just two months ago we were talking about the possibility of the broad-based S&P 500 (SNPINDEX:^GSPC) breaching its old "supports" and heading to a fresh two-year low. Today, we're well within striking distance of the S&P 500 claiming an all-time record closing high (which happens to be 2,130.82, set back on May 21, 2015).
How did we go from the worst start in recorded history to the most voracious rally within a quarter in decades? While no one knows the answer to this question with any certainty, I'd propose three factors were at play.
Three probable reasons behind the market's surprising Q1 turnaround
First, it's plausible that investors' emotions calmed a bit. Emotions are best left out of investing, but that only works in instances where investors are thinking long-term. Hedge funds are often geared to performing for their members in the short-term, which means some big money movements during the first quarter were likely influenced more by short-term emotions than actual fundamentals.
Secondly, it appears investors decided that global and domestic growth concerns aren't as dire as they thought. Sure, China may have produced its weakest full year of GDP growth in quite some time in 2015, but it's still growing its GDP at a brisk 6.8% as of the fourth quarter. Similarly, slower GDP growth in the U.S. has been met with dovish Federal Reserve policy. Once expected to hike lending rates four times in 2016, the Fed has backed off its tightening stance and is now looking to give the U.S. economy more time to find its footing. Although global growth may not be what investors wish it was, it doesn't appear as if a domestic or global recession is looming either.
Finally, history may have played a role. An interesting statistic proposed by ZeroHedge recently is that the Dow Jones Industrial Average has dropped at least 10% in 26 quarters since 1900 and managed to recover at least 8% from its low during the quarter. ZeroHedge points out that all but two of these drops occurred during secular bear markets.
What I'd add is that history has unequivocally shown that markets tend to move higher over time, and investors may have taken advantage of this perfect track record. Since 1950, the S&P 500 has undergone 35 stock market corrections, and every single one of those corrections has been completely erased by a bull market rally or bear market rebound in a matter of weeks, months, or years. There is no better track record than that.
Moves you should consider making with the S&P 500 nearing a new all-time high
With the S&P 500 seemingly knocking on the door of 2,100, you might be wondering if it's time to change up your investing strategy. My suggestion would be to consider implementing three key strategies to take advantage of the market regardless of where it heads in the short-term.
1. Think long-term and keep buying on a regular basis
The first thing you'll want to do is not stray away from your usual investing habits. If you invest a certain sum of money every month or quarter, you should continue to do so regardless of where the stock market indexes are valued. Since the stock market has demonstrated a tendency to increase in value over time, buying at regular intervals should allow you to dollar-cost average into high quality stocks at a lower long-term price.
Additionally, buying and holding over the long run will give you a major advantage come tax time. When it comes time to take profits on your holdings, long-term capital gains are taxed at 0%, 15%, or 20%, based on your adjusted gross income. By comparison, short-term capital gains, or assets held for one year or less, are taxed at a rate commensurate with your peak marginal tax rate. This could mean paying 10%, to as high as 39.6%, on any short-term gains.
2. Reassess your portfolio monthly
The second thing you'll want to do is to reassess your portfolio on a monthly basis, which really shouldn't take much time at all and should be done in both rising and falling markets. In effect, all you're doing is looking back at your investment thesis in a company and deciding if the reasons why you bought that company in the first place are still valid. This does mean you'll need to keep up with potentially thesis-altering news for the companies that you own, but it doesn't mean you should be waiting on the edge of your seat for every five-cent uptick or downtick in share price.
What are thesis-altering events? I'd define them as anything that disrupts a company's business model or long-term outlook. It could be a new innovation or product from a competitor, a change in tax laws or regulations within an industry, or a failed product or service that was critical to a company's long-term growth. If your investment thesis no longer holds water for a company, it may be time to consider selling.
3. Protect yourself with dividend stocks
Finally, you may want to consider buffering your portfolio with high-quality dividend stocks.
Dividend stocks offer a number of advantages to investors in any market environment. First, they act as a beacon alerting investors to a successful business model. Presumably, businesses wouldn't be sharing their profits with investors if they weren't viewed as stable and profitable. Secondly, dividend payments can help hedge against stock market corrections. This hedge becomes more pronounced over time, as you'll see in the next point. Third, dividends can be reinvested back into more shares of dividend-paying stocks, thus setting yourself up for a revolving pattern of bigger dividends and more shares of stock owned. This process is commonly known as compounding among the investing community.
Also, understand that buying dividend stocks is about more than just yield. Sometimes dividend yields rise because share prices are falling. If that's the case, you'll need to be vigilant that a company's business model is still healthy and set to grow over the long-term.
Long story short, a possible new all-time high for the S&P 500 shouldn't mean a revamp to your investing strategy.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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