Stock market investors are either passive (i.e., follow an index) or active (i.e., buying and selling companies considered under-or over-valued). These are the two broad categories of stock market investors.
Regardless of the category they belong to, every investor wants two things – to buy the dip and to avoid buying at the top. Naturally, no one knows how deep the dip will go or when a top is in place. However, these are the two things everyone prepares for.
With the stock market indices at all-time highs during the end of the year trading, the risk is that whoever buys here may buy the top. Is that so bad?
Buying the Top
While many are afraid of investing at all-time highs, a study by JP Morgan shows just the opposite. What JP Morgan did was to compare investing at all-time highs with investing on any other random day. The returns, calculated over a period of one, three, and five years, were better on average when investing at all-time highs than on any other day.
In other words, statistically speaking, investing in today’s stock market offers better chances for a positive outcome. Therefore, buying the top should not be so scary and is less risky than buying the dip. After all, as mentioned earlier, when buying the dip, one goes against the major trend – it is a contrarian. However, when buying at all-time highs, one goes with the trend.
Equities still offer interesting perspectives into 2021. This year showed an increased divergence between value and growth stocks. Value investors focus on finding companies that are undervalued, while growth investors favour companies with strong earnings growth. We should not be surprised to see value trying to catch up in 2021, as value inevitably does during economic expansion.
The consensus is that the world’s economies will bounce back strongly in the second half of the year, should the pandemic ease and vaccination efforts pay off. The consensus also is that 2021 earnings will exceed 2019 and even 2020 – further supporting higher equity prices.
All in all, investors should not be afraid of buying the top. The risks of buying the dip far outpace the ones of buying the top, so betting on even higher equity prices in 2021 is not unusual under the current circumstances.