The Market “Melt-Up” – A Note to the Young Investor

Happy New Year! As I write this in the first few days of 2018, North American stock markets are going up and breaking new records on a daily basis. The economy looks good, data shows that main street investors are jumping into stocks and the 2008 economic crisis is a distant memory. Everyone is optimistic. Stocks have been providing tremendous returns.

As an example, the S&P 500 has gone up by about 100% in the past 5 years. This represents a compound rate of return of approximately 15% per year – a historically high number (remember that 30-year rolling average rate of returns for this index is between 8% – 14% – see chart here).

S& P 500 (5 Year Chart)

Can it continue?

If you look hard enough, you will likely come across articles in the financial media arguing both sides of that question. One side argues that market will continue to go higher because of continued low interest rates, strong economic growth, Washington’s tax plan, etc. The opposite viewpoint argues that our governments have too much debt on their balance sheets, market returns always revert to the mean and we’re in the classic “Melt-Up” phase where Main Street investors drive up market prices (FOMO) just before market prices inevitability start to decline.

I can tell you with confidence that both sides are correct. That is, stock market prices will continue to go higher – until it doesn’t upon which it will fall drastically.  I know this because it is what has always happened.

S&P 500 Index (All Time, Log Scale)

So what’s a young investor to do?

First, you need to acknowledge that you cannot predict the future. Without the benefit of hindsight, it is impossible to determine when market prices will hit their peak. Don’t try!

Second, ensure you are investing with money you will not need to spend in the near future (e.g., at least 7+ years).

Finally, remember that as a young investor, you will live a wealthy life if you:

• Practice Make – Save – Live the discipline to regularly save a portion of your earnings;
• Start early and maximize your investment time horizon by using your savings to purchase assets that generate passive income; and
• Have the conviction to ignore the noise and to continue investing when market prices inevitably decline – even if you suffer a significant loss (on paper).