Investing in the stock market can be a maddening task for the amateur investor. As a friend in the real estate investing business once remarked, the stock market is the only place one can be right and still lose money.
That’s not totally accurate. The bond market can be just as unforgiving.
But he was correct, being right isn’t enough.
Take Microsoft for example. Microsoft hit a high of $53.61 in December of 1999 on expectations that the company would dominate the market for operating systems for the foreseeable future and its earnings would continue to increase at a rapid clip.
Both of those things happened. Microsoft remains the dominant provider of operating systems, and from year-end 1999 through year-end 2013 earnings compounded at almost 10% per year.
But over that time-period, Microsoft shares were dead money (see chart).
The same can be true of the broader stock market. The economy is strong and it is expected to stay strong. Growth came in at more than 4% in the second quarter and the Atlanta Fed GDPNOW tracking estimate is running at 4.6% for the third quarter. Strong economic growth means strong corporate profits and since profits are the driver of stock prices, shouldn’t the stock market be up as well?
That’s one scenario, but a strong economy doesn’t guarantee a strong stock market. If too many investors already anticipate strong growth, its realization may not move the needle.
The takeaway: clear skies ahead for the economy shouldn’t be viewed as a green light to take more risk than you are willing and able to bear.