The S&P500 (SNPINDEX: ^GSPC) has soared through 24 all-time highs in 2024, after going more than 500 trading days without a single one. Factors contributing to these gains include expected interest rate cuts and excitement about artificial intelligence (AI), both of which promise to boost economic growth.
Indeed, Nvidia has become the ultimate AI stock, accounting for about a third of the S&P 500’s year-to-date gains, according to Morning star. Much like the chipmaker’s string of stellar financial reports, investors tend to wonder how long the S&P 500 can maintain its momentum without a correction.
These are the two worst mistakes investors can make right now.
Mistake 1: Avoiding stocks in anticipation of a market correction
Fear is a natural reaction when the S&P 500 bounces between record highs, but avoiding the stock market for fear of a correction is a bad strategy. In a recent article, strategists at Fidelity Wealth Management explained that the S&P 500 has historically performed very well after hitting a new high.
“Since 1950, in the year following a record high, the average total return for the S&P 500 index has been 12.7%, compared to 12.4% for other twelve-month periods. If you look back at every time the S&P 500 hit an all-time high, you can see that the market often went even higher and then hit new all-time highs.”
Other Wall Street strategists have a similar view. Madison Faller and Matthew Landon op JPMorgan Chase wrote the following in a recent article:
“If you had invested at the highest levels in the S&P 500 over the past fifty years (going back to 1970), your investment would have been higher 70% of the time a year later, with an average return of 9.4%. — versus the average 9% when investing at any time.”
The bottom line: While it may seem wise to avoid the stock market at record highs, investors who try to time the market often run into trouble. 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 was lost in the corrections themselves.”
Mistake 2: Ignoring Valuations When Buying Stocks
Getting carried away by the stock market momentum can be just as dangerous as avoiding the stock market altogether. Instead of worrying, some investors become overconfident as the S&P 500 moves back and forth between highs. They feel like they can do no wrong as their portfolios keep getting bigger. But ignoring valuations to chase headlines is a recipe for disaster.
The sobering truth is that 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 ten-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 aware of this when making decisions.
No stock, no matter how good the underlying business, is worth buying at any price. Warren Buffett shared a similar view in his 1982 letter to Berkshire Hathaway shareholders. “A purchase price that is too high for the stock of an excellent company could undo the effects of another decade of favorable business developments.”
There are many ways to value a stock. Some investors like ratios, while others prefer more complex approaches such as discounted cash flow models. Either way, the goal is to determine whether a given 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 ratio or price-to-earnings ratio over the past two or three years unless the company has undergone a significant change.
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JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Trevor Jennevine has positions at Nvidia. The Motley Fool holds positions in and recommends Berkshire Hathaway, JPMorgan Chase, and Nvidia. The Motley Fool has a disclosure policy.
The Stock Market Roars Past Record Highs: The Two Worst Mistakes Investors Can Make Right Now was originally published by The Motley Fool
