Stock indices continue to grind higher, with the S&P recently closing at a record high of 6,532. Investor optimism is powered by hopes for rate cuts, easing Treasury yields, and strong earnings momentum. Still, some market commentators caution that rapid gains and stretched valuations warrant close scrutiny.
In September 1995, Peter Lynch told Worth Magazine:
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in the corrections themselves.”
It’s an interesting concept, borne out in the data. Investors who sell too early or under-allocate during volatile periods often trail the index significantly. JP Morgan calculated that $10,000 invested in the S&P 500 between January 2003 and December 2022 would have returned 9.8% annually — but missing just the 10 best days would have slashed that to 5.6%. The kicker? As Pippa Stevens noted to Business Insider, seven of those 10 best days occurred within 15 days of the 10 worst.
Timing the market isn’t just hard, then — it’s nearly impossible – like finding a needle in a haystack. To find that needle, a multitude of events would need to go right. The same is true in the economy: it takes a multitude of things going wrong for the market to truly collapse.
It tends not to be one factor in isolation that causes the house of cards to fall. Take the TGA (Treasury General Account) as an example. This is the U.S. Treasury’s cash balance held at the Federal Reserve, which has existed for decades but became a much more prominent policy tool after the Global Financial Crisis. At present, the Treasury is issuing debt to rebuild the TGA balance. This can withdraw liquidity from the system and mimic the effects of quantitative tightening, but it has not been sufficient to bring markets down in of itself.
Historically, collapses have occurred when multiple stresses converged. For example, in mid-2023 when the Treasury rebuilt the TGA after the debt-ceiling standoff, it withdrew nearly a trillion dollars of liquidity from the system in just a few months. On its own, that might not have been destabilising. But layered on top of aggressive Federal Reserve rate hikes, ongoing quantitative tightening, and vulnerabilities in regional banks’ balance sheets, it contributed to the regional banking crisis that saw institutions like Silicon Valley Bank, Signature Bank, and First Republic fail. It was the combination of these factors, not the TGA alone, that created the shock.
This brings us back to the “needle in a haystack” point: successfully predicting all these events aligning requires a certain amount of luck, something anyone who has ever called a drawdown correctly will admit.
Stanley Druckenmiller has admitted that part of his early success came from his youth and inexperience — he was named Director of Research of Pittsburgh National Bank, in part because his boss believed he was too naïve not to charge into a secular bull market when veterans, scarred by a decade of losses, couldn’t. Experience builds caution, but it can also anchor investors to fear. Kahneman and Tversky’s prospect theory explains why: losses sting more than gains please, a bias magnified for professional managers handling billions.
Today, though, the investor base looks different. Financial literacy is no longer reserved for the college-educated “Chad” it’s accessible to anyone who wants it, and even to those who don’t actively seek it. Simply buying and holding the “Magnificent Seven” stocks would have served investors extremely well over the past five years. These are household names that people not only know but also use and understand in their daily lives.
In the past, markets would often wait for what was called “capitulation” the point when investors, particularly retail, collectively give up on holding risk assets and sell en masse, usually after prolonged losses. It has often marked a sentiment bottom. I question whether that will be the case in the future; with financial literacy where it is, retail understand the importance of buy and hold. Which means, if the labour market remains resilient and people aren’t forced to sell, perhaps the very notion of retail capitulation fades away.
Still, market history warns against complacency. The GFC saw the S&P 500 fall 57% from 2007 peak to 2009 trough, taking approximately six years to recover. Those who lived through it haven’t forgotten. So where does that leave us today? Are we in an era where structural resilience, retail literacy, and buy-and-hold discipline mean markets can grind higher for longer? Or is this just the set-up for the next painful correction?
From the desk of IGB