Focusing Too Much on a Bull Market Could Lead You Astray

Talk of a bull market may be exciting, but you may want to temper that a bit. Here’s why: Even if the market’s overall value soars, that doesn’t necessarily mean your investments will make money.

Take as one example the early part of 2023, when the S&P 500 index rose 20% over the previous year. A 20% gain sounds great. But one problem is that in 2022, the market hit such lows that this year’s gains aren’t doing much more than helping to recover last year’s losses.

In other words, that bull market is simply taking many investors back to their break-even point. And maybe it’s not even getting them back to break-even.

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Plus, when you delve into the specifics of a bull market, you may discover that a very small sector of businesses is driving almost all the upward motion, and you may or may not be invested in that specific sector.

A handful of tech stocks at the top

Let’s look at a recent example. In the spring of 2023 as the stock market rallied, a small group of tech stocks was responsible for most of the S&P 500’s gains. If your money was invested in most other stocks — as a well-diversified portfolio should be — not a lot was happening in your overall portfolio values. You may have been scratching your head, wondering why you weren’t sharing in those incredible market gains that you were reading about and hearing about in the news.

This point was driven home recently when another index, the Nasdaq 100, had to do a “special rebalance” because it was out of compliance with the U.S. Securities and Exchange Commission’s rule on fund diversification. Just seven companies accounted for 55% of the weight in the index. They were Microsoft, Apple, Nvidia, Amazon.com, Tesla, Alphabet and Meta. The concern was that this handful of companies was distorting the health of the market, and balance was needed to correct that.

Imagine if just one or two of those companies had a poor quarter or a poor year; the entire Nasdaq index would be disproportionately impacted. The purpose of an index is to spread risk among many companies, so when any company or companies consume too much of the index’s weight, the SEC requires adjustments to be made.

As you can see from these examples, bull markets can sometimes be misleading. At the time I am writing this (September 2023), if you equally weighted the 500 stocks that compose the S&P 500, they are up less than 4% for the year. Yet, the overall S&P 500 is up 17%.

Some suggestions for what to do instead

If you are beginning to deduce that you should be wary about the emphasis that gets placed on a bull market, you are correct. But what should you do instead?

Here are a few suggestions:

Study the broader market. People often focus on the S&P 500, but there are other stock indexes to look at. Each has its own advantages. By examining them, you can get a bigger and clearer picture of the market overall. The Russell 2000 index is a stock market index that measures the value of 2,000 smaller companies. Many mutual funds and exchange-traded funds are based on or tied to the Russell 2000.

Another stock index is the Wilshire 5000, which tracks almost every publicly traded company in the U.S. That arguably makes the Wilshire 5000 the best benchmark for comparing returns.

Look at longer-term performance. Don’t get fixated on the fact that a stock has performed remarkably well since a particular date. Let’s say a stock’s value has grown astronomically over the last seven months. That’s wonderful, but what if you went back eight months? Or a year? Or five years? What does the performance look like over the long haul?

That longer time line can give you a better picture of how well the company and its stock have historically performed and whether what is happening in the moment might be an anomaly.

Give more attention to avoiding big losses. Big losses hurt more than big gains help. Why is this so? Because a percentage loss cannot be made up by gaining back the same percentage. Let’s say you have a $10,000 investment and take a 25% loss this week. That drops your investment to $7,500. But next week, the market rallies and you gain 25%. Are you back to your original $10,000 investment? No, because 25% of $7,500 is $1,875, which brings you to $9,375. You are actually down $625, even though you lost 25% and gained 25%.

Now, let’s say the timing was reversed and the 25% gain came first. Your $10,000 investment would jump to $12,500, a $2,500 increase. But then comes the 25% loss, which would cost you $3,125. You are back to that net figure of $9,375. Indeed, big losses hurt more than big gains help in calculating overall returns.

Be especially careful if you are in retirement. Those big losses create a double whammy if you are in retirement and withdrawing money from your investments for living expenses. Losses on top of withdrawals can cause a portfolio to evaporate quickly. This is why, as you near retirement, it’s a good idea to revisit your portfolio and consider reducing some of the risk.

Keep things in perspective

This doesn’t mean you should stop pulling for a bull market. But you should keep things in perspective and remember that bull markets — especially ones driven by a small portion of the S&P 500 — could be giving you an inaccurate impression of what the overall market is actually doing.

The better handle you can get on what’s happening, the better your decisions will be. You can do that on your own, but it’s also a good idea to find a financial professional who can provide guidance and help you keep tabs on the bigger picture.

If you’re going to join the excited bull-market chatter, you should at least truly know what it is you’re excited about.

Ronnie Blair contributed to this article.

The appearances in Kiplinger were obtained through a public relations program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

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