Performance Anxiety: Why Investors Continue to Chase Stocks Higher

Stocks have to be the only entity in the world that become more attractive to investors as the price goes up. Imagine if prices at Macy’s were at all-time highs this Christmas? It’s safe to say there’d be no lines and unbelievable service.  But if you apply the same attribute to the Dow Jones Industrials, for example, it’s only then that people really start to get interested.

“Decades of research into behavioral analysis suggests that people chase returns,” says Jeff Kleintop, chief market strategist at LPL Financial who just published a report on the subject. “They don’t get ahead of them, they get behind them.”

And right now there’s an even greater enticement out there than the seemingly endless string of new all-time highs that stocks have posted this year. Specifically, five-year average returns.

That’s right. Kleintop’s research shows that it’s five-year average returns that influence investors the most, acknowledging that the one-year and three-year averages have been hugely positive for years already.

Of course it’s no secret that the second half of 2008 was a disaster for the stock market, but Kleintop says for the first time in years, the one, three and five-year averages are all boasting double-digits returns. A number that not only makes 2% bond returns look all the more feeble, but one that is also about to get even great as the averages shoot north of 20%.

“It’s the 5-year trailing return that individual investors have (historically) tended to follow with the (money)-flows into U.S. equity mutual funds,” he says.

“Investors are worried they’re missing out and they’re finally moving in en masse,” he says. “Individual investors have trillions of dollars that they could move into this market and they’re just starting to do it.”

According to Russell Investments, hitting a high mark doesn’t necessarily signal the end of this rally.  So it may not be too late for investing newcomers.  As the chart below shows, most of the 62 market peaks since 1995 don’t look like peaks when considered in a historical context.  And when you view current valuations, stocks aren’t necessarily over-valued.

 

All things considered, this bull market may be long from over.

Sources: Russell Investments, Morningstar, Bloomberg and Yahoo! Finance