No need to fear a record high

The S&P 500 index reached a record high last week, and S&P 500 futures traded above 3,000 for the first time. With the market making all-time highs and after year-to-date returns of 20%, investors might be reluctant to put money into equities for fear of a substantial correction. But history suggests that a record high is not a sign of a market peak:

• Since 1950, the S&P 500 has had a six-month subsequent price return of 4.7% on average after hitting record highs, versus a 4.2% six-month return on any other day.
• Large falls are also less common after record highs. The probability of a greater-than-5% loss over the next six months following an all-time high is 10.7%, versus 18.1% following any other day.
• Positive performance also tends to persist. Based on monthly returns, since 1945 the S&P 500 has spent two-thirds of the time within 10% of an all-time high. Two-thirds of the time the index has risen by at least a third from its starting point over the next four years.

The benefit of staying invested for long-term growth is clear, and over our six- to 12-month tactical time horizon we also continue to overweight equities with a regionally selective approach. Equities remain attractive relative to bonds – with a global equity risk premium of 5.8% compared with a long-term average of 3.5% – and in our base case we expect equities to edge higher. But the first half will be a tough act to follow. Global equities have returned 18% year-to-date and valuations are back above their 20-year average. We think second half returns are likely to be a lot lower than in the first half. In addition, in the near term, given downside risks, we would also recommend countercyclical positions.

Past performance also suggests that it makes sense to put any new money to work all at once. Since 1945, putting funds directly to work in a 60% stock, 40% bond portfolio — rather than using a 12-month phase-in strategy — would have added an average 4.4% to returns.

That said, we have to acknowledge that it is emotionally challenging to put cash to work in the stock market after such a strong rally. There are a number of strategies that can help investors manage their aversion to near-term risk, while allowing them to invest for the long term:

Putting cash to work over time.

• Also known as "dollar cost averaging," putting cash into the market in phases can help mitigate any risk of "bad timing." We recommend putting all of the cash allocated to bonds to work at once, since there is limited drawdown risk for that asset class, while committing to phase out of cash into stocks over a set schedule. If there is a market dip of at least 5% during the phase-in process, accelerating the next phase-in tranche can help enhance returns.

Call *options.

• The biggest risk of any phase-in strategy is "opportunity cost," where markets rally sharply, resulting in forgone gains when you eventually buy at a higher price. Call options are one way to help defray this opportunity cost.

Writing puts.

• A put-writing strategy enables you to earn a premium by giving others the right to sell you a security at an agreed-upon price. If the market doesn’t fall, the option expires worthless, and you keep the premium. If the market falls, you end up taking delivery of the stock (which you were planning to buy anyway), typically at a discount to the market price when you wrote the put. While this strategy is not without its drawbacks, it can allow investors to “get paid to wait” to buy into the market at a lower level (should it materialize).

Bottom line

With US equities making record highs and after returns of 20% year-to-date, investors might be wary of putting money into the market for fear of a correction. But history suggests that a record high is not a sign of a market peak. We see further upside for stocks, but think second half returns are likely to be a lot lower than in the first half. For investors concerned about “bad timing” we recommend several strategies to help investors manage their aversion to near-term risk and put money to work.

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*Options and futures are not suitable for all investors, and trading in these instruments is considered risky and may be appropriate only for sophisticated investors. Past performance is not necessarily indicative of future results. Various theoretical explanations of the risks associated with these instruments have been published. Prior to buying or selling an option, and for the complete risks relating to options, you must receive a copy of "The Characteristics and Risks of Standardized Options." You may read the document at https://www.optionsclearing.com/about/publications/character-risks.jsp or by writing to UBS Financial Services, Inc., 1200 Harbor Boulevard, Weehawken, NJ, 07086.”