Don't get greedy in the late stages of a rally - MoneySense

Don’t get greedy in the late stages of a rally

The Dow just posted its fourth fastest 1,000 point gain ever, but investors shouldn’t get too excited

Caution Sign

Caution Sign

If you’ve been following the U.S. markets at all you know they’re on a pretty impressive run. The Dow Jones Industrial Average recently smashed through another milestone, topping 23,000 points. It took just 76 days for the Dow to jump 1,000 points, which is the fourth fastest 1,000-point increase in the Blue Chip index’s history.

Now here’s why that shouldn’t excite you.

As David Rosenberg, chief economist and strategist at Gluskin Sheff, writes in a recent note to clients, “the speed of this achievement is not what is important.” His point? Investors need to be mindful of just how long this rally has gone on for and consider what happens when it ends.

After the rally

Following the last bull market, Rosenberg points out that it took 2,117 days to breach the next 1,000-point threshold. This isn’t an anomaly. On average it takes 2,176 days—nearly six years—after the end of a bull phase before the Dow makes its next 1,000-point gain, explains Rosenberg.

While it’s hard for investors to not feel jubilant when markets touch new highs, many market strategists say we’re overdue for market retreat based on historical trends. If, or when, that happens, investors could suffer stiff losses that will take years to recover from.

Read: The hard sell

The length of this bull market isn’t the only reason Rosenberg urges caution. What concerns Rosenberg are the parallels he sees between the current market and October 1987, the stock market collapse that wiped 20% off the Dow in a single day. Excessive valuations, low volatility, high investor sentiment and an untested leadership at the U.S. Federal reserve were hallmarks of that bleak period for investors 30 years ago. You can make those same observations about the market today and that should give investors pause.

Proceed with caution

Professional money managers are turning cautious. The managers at Steadyhand Investment Funds in Vancouver have lowered their stock weightings, cut their bond exposure and add that they are carrying considerably more cash than normal. It’s not that they feel a crash is imminent, but they are being prudent.

The 30th anniversary of the 1987 crash offers a sobering reminder of why it’s important to have some skepticism about how long this rally can last. And yet, while there may be parallels with 1987, there are differences too. As Sam Stovall, chief investment strategist at CFRA in New York explains, the S&P 500, the other major U.S. benchmark, peaked nearly two months prior to the ’87 crash.

By the eve of the crash, the market had already declined 16%. In retrospect, Stovall suggests investors should have been on alert that something ominous was in the works.

So maybe history won’t repeat itself—but does that matter?

Don’t get greedy

Here’s a bit of simple math to consider. Let’s say you invested $10,000 in the Dow at its low in March 2009. After its 230% increase since that time, your investment would now be worth $23,000.

For argument’s sake, let’s say we do see a repeat of 1987 and the market falls 20%. Your portfolio now is worth just $18,400. Sure you’d still be up on your initial investment, but the sudden drop would cost you more than half of your gains. Investors need to consider what’s worth more to them: the chance that the market will press higher, or protecting some already impressive gains?

It wouldn’t be the first time investors held on too long. As Rosenberg points out, there are always investors left asking themselves “Why was I so greedy?”

So, do you still like this rally?