The stock market has been on an incredible run since the S&P 500(SNPINDEX: ^GSPC) hit the bottom of the prior a bear market in October 2022. Since then, the index is up about 70% as of this writing. Many stocks have seen even bigger gains in that 26-month period.
Most people think that those gains are just the beginning of a strong bull market. In fact, 56.4% of consumers expect stock prices to increase over the next year, according to the latest US Consumer Confidence report from the Conference Board. Although that may not sound like an overwhelming proportion of the population, it is the highest number ever since the survey began collecting this data 37 years ago.
Stock values are influenced by two main factors — financial results and investor sentiment — and many companies driving the bull market have produced incredible financial results over the past two years. But smart investors can't ignore that more people are optimistic about future stock market returns than ever, which has driven prices higher.
Warren Buffett has a fitting piece of advice for the situation.
Photo source: The Motley Fool.
In October 2008, the S&P 500 was already down 40% from its 2007 peak, and many investors thought things could get worse. In an op-ed for The New York TimesBuffett wrote, “Fear is now common, catching even seasoned investors.” In fact, US consumers have never been more pessimistic about the future of the stock market, according to a Conference Board survey.
Buffett was forced to remind readers of the simple rule he laid down Berkshire Hathaway's (NYSE: BRK.A)(NYSE: BRK.B) 1986 letter to shareholders. “We simply try to be fearful when others are greedy and to be greedy only when others are fearful.”
When Buffett wrote those words in 1987 (to repeat Berkshire's 1986 financial results), he noted, “There is little fear to be seen on Wall Street.” At the time, investors had bid up stock prices, and as a result, he could not find any suitable equity investments for Berkshire's portfolio. Instead, he piled about $700 million of Berkshire's money into Treasury bonds.
He wasn't particularly thrilled about it, either. “At best, the bonds are mediocre investments,” he said. “They were simply the least unpleasant alternative at the time.”
In 2008, he applied the exact same idea to the market with opposite results. He shifted his personal portfolio from 100% government bonds to 100% US equities. It was an extremely fortunate move for the Oracle of Omaha. The S&P 500 bottomed out a few months after Buffett published his op-ed and went on to produce incredible returns over the next 15 years.
In 2024, Buffett appears to be again following his rule from nearly 40 years ago. As prices have risen over the past two years, Buffett has consistently sold some of Berkshire's largest equity holdings. Its sales accelerated in 2024 as investors became increasingly bullish, pushing Berkshire Hathaway's cash and Treasury bill position to a record $325 billion at the end of the third quarter.
Discussing the growing cash pile at the 2024 shareholder meeting in May, Buffett echoed his comments in 1986. “I don't think anybody sitting at this table has any idea how to use it effectively, and so we don't use it.” The alternatives to Treasury bills are not very attractive to Buffett right now.
Once again, investors find themselves in a market environment where there is “little fear to be seen on Wall Street.” Equity valuations have risen to levels last seen during the dot-com bubble. Investors are more confident than ever that stock prices will be higher a year from now and are putting their money where their mouths are with record inflows into equity exchange traded funds (ETFs) this year.
However, that does not mean that investors should sell all their stocks and keep their money in government bonds. But it requires careful consideration of their investments.
Another quote from Buffett is relevant here: “The less prudence with which others conduct their affairs, the more prudence we should conduct ourselves.” Buffett wrote that in his shareholder letter in 1988. At the time, he was describing the market for arbitrage opportunities as excess capital had flooded the market, reducing potential returns while increasing risk.
Buffett repeated himself in his 2017 shareholder letter, which he wrote at a time when investors were more confident than ever in the future of the stock market. Although the market declined somewhat that year, it didn't exactly fall into bear market territory.
Being scared doesn't mean running away from the stock market altogether. It means that investors need to be smarter than the rest of the crowd if they want to secure solid returns.
It will be more difficult to find suitable investments for your portfolio as investor confidence tends to push stock prices up, making them less attractive. But Buffett's recent portfolio moves suggest there are still plenty of investments that could produce great returns for shareholders if they know where to look.
Although Buffett has been a big seller of stocks in 2024, he has made several relatively small purchases. Those purchases have one thing in common: They're all close to the smallest-sized companies that Berkshire can invest in to move the needle for its massive portfolio.
But an individual could buy enough for a relatively small portfolio. Buffett's moves point to the possibility that there may be more opportunities for individual investors in small- and mid-cap stocks than in large-cap stocks, including those represented by the S&P 500.
If you don't want to take the time to look for great individual stocks, you could buy an index fund or two. The Vanguard Extended Market ETF(NYSEMKT: VXF) offers a way to invest in the entire US stock market other than the S&P 500. Investors may also want to consider index funds that focus on value stocks as another option.
No one knows if stocks will continue to move higher in 2025, but Buffett's advice has been very valuable for several decades now. It's worth taking his words into account when planning your next moves as an investor.
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Adam Levi does not have a position in any of the stocks mentioned. The Motley Fool has positions in Berkshire Hathaway and recommends it. The Motley Fool has a disclosure policy.
