Stock market records: some down-to-earth advice on how to respond to dazzling heights

Investors have had plenty of reasons to smile recently. Stock markets from Europe to Japan and from India to the US have broken records in recent weeks. The S&P 500 notched its first record high close in two years in January. The US top index then broke through the 5,000-point mark. After Nvidia presented impressive growth figures on 22 February, the S&P 500 continued its record-breaking rally. It was on the exact same day that the European STOXX 600 also broke its record.

Even the Japanese Nikkei 225 broke its record high several times this year. This is remarkable, as the Japanese stock market has been synonymous with stagnation for decades. Its previous record dates back to … 1989. No wonder some banks adjusted their stock market outlook for 2024 after only a few weeks.

Don't worry, be happy?

The current stock market upturn is all the more striking when you consider that we have just gone through two years of sharp rate hikes. In theory, higher interest rates have a negative effect on shares. This is because they make bonds and other fixed-income products such as term deposit accounts more attractive. If lower risk bonds currently yield 4–5% and higher risk shares may potentially yield 6–7%, many investors should see bonds as the better alternative.

In theory, the combination of higher interest rates and high inflation should slow down equities. At the same time, the geopolitical embers between the US and China are continuing to smoulder, and we have wars raging in various places. In addition, 2024 is a busy election year. In short, we are facing plenty of uncertainties. And if there’s one thing equity investors dislike, it’s uncertainty. But if all this is not enough to slow down the rally, what would slow down the enthusiasm on the stock markets?

The current atmosphere already evokes vague memories of previous periods of (extreme) market optimism. The fact that cryptocurrencies have come out of hibernation only contributes to the nervous feeling. The health of the US equity market has been the subject of intense debate in recent weeks.

Recession? What recession?

And yet there are several reasons to consider the stock market rally as a rational phenomenon. As central banks around the world started raising rates in record time, many analysts warned of the danger of a recession and falling corporate earnings. In early 2023, the consensus was that the US economy – the largest in the world – would grow by just 0.7%. In reality, it grew by more than three times that. The job market remained healthy, and a wide range of companies released strong results again and again.

The US economy continues to defy gravity today, with growth also forecast for the first quarter of this year. Despite a slowdown in China, whose weak stock market performance is an exception to the global trend, and the poor economic figures in the eurozone, the IMF has also revised its global growth forecasts upwards.

With thanks to AI

Many investors are also expecting the wave of investment in AI to boost the economy. If AI is used on a larger scale, it can help companies to save costs, develop new applications and add more value, which will benefit economic growth and business profits. According to the AI believers, the idea that an AI bubble is forming in the markets is an exaggeration. Take AI favourite Nvidia: they say that the Nvidia share doubling several times in just one year is not just based on a hype, but on hard figures and strong expectations. In the last quarter, Nvidia posted sales that were more than three times those in the same period last year. JPMorgan even noted that the so-called Magnificent Seven – Apple, Alphabet, Amazon, Meta, Microsoft, Nvidia and Tesla – are now trading cheaper than they were five years ago.

The art of sitting still

Investors are currently in a difficult position where they are straddled between two views. On the one hand, there see warning lights that the stock markets may be too optimistic. On the other hand, there are also reasons to justify the rally. So, what should you (and shouldn't) you do with your investments? This mainly depends on what type of investor you are.

Are you a long-term investor? Then it may be better to remain invested rather than sell all your investments. No matter how many computer models and PhDs people have, no one can predict what the stock markets will do in the short term. Consequently, it is better to simply sit still and not try to time the market to make sure you don't miss the boat when the stock market rises.

Despite their many dips, the stock markets are showing an upward trend in the long term. The MSCI World Total Return index is a representative measure of this. This global equity index measures the total return of nearly 1,500 stocks in 23 markets. A calculation based on Bloomberg data shows that those who invested USD 100 in 1974 have seen their investment increase to 8301^USD at the end of 2023. In those 50 years, the index ended the year in the green 38 times and in the red 12 times. (In the past 20 years, it closed in the green 15 times and in the red 5 times).

Ideas for hedging risks

Are you a long-term investor? Or do you invest in funds that are already actively adjusted and managed anyway? Then doing nothing may be an interesting strategy. If these dazzling heights are scaring you, or if you are a more active investor, you may consider several other ideas to try and hedge the risks:

• You can reduce your exposure to equities and increase your exposure to bonds in an attempt to reduce risk and volatility.
• You can reduce the weighting of US equities and increase the exposure to European equities. They are generally less cyclical with a more attractive valuation than US equities.
• You can increase your exposure to dividend equities as they are likely to be less volatile should the stock market let off some steam.
• If necessary, use stop-loss orders to cut any losses. This allows you to set a specific price level at which your shares are automatically sold, which may help you to limit damage in the event of a sharp fall in the market.
• If you are a more advanced and dynamic investor, you can develop a hedging strategy that invests a small part of your portfolio in derivative instruments, such as a basket of put options. These put options allow you to sell certain assets at a predetermined price within a specified period. This means that if market prices fall, the value of these options increases, which helps to offset any potential losses in the rest of the portfolio.
• Consider adding gold and/or other precious metalsto your portfolio. Precious metals are often seen as a safe haven against market uncertainty. Adding a percentage of gold or other precious metals to your portfolio can act as a buffer against market volatility.

Not sure which direction the stock markets are taking?

Also consider making regular investments. This allows you to spread your investments across different sectors and over time.