Two of the developed world’s most important equity indices are at all-time highs. The S&P 500 has reached 1,941 and Germany’s DAX 30 has crossed above 10,000 for the first time. Britain’s FTSE 100, meanwhile, has lately come within less than 1% of its record peak of 6951, which it registered back in the year 2,000. Is all this a cause for optimism?
Technical analysis is absolutely clear on this clear on this point: fresh all-time highs are bullish. Indeed, a popular saying among traders is “new high, new buy.” The straightforward logic is that once a price enters ‘blue-sky territory’ there are obviously no past price levels standing in its way. The breakout is worth buying, therefore, in anticipation of continued gains.
Nevertheless, many investors get nervous when an index hits all-time high. Particularly to those of a contrarian mindset, the idea of buying the S&P 500 today at unprecedented levels after a five-year boom must seem counterintuitive. After all, wasn’t the market at all-time high in 1929, 1987, 2000 and 2007, just before it suffered some of the most savage sell-offs in history?
Rather than rely on folk wisdom or gut-feelings, I have taken a look back at the S&P’s historical performance in the wake of fresh monthly closing highs. Going back to 1928, there have been 174 months in which the market has ended a month at a record high. The returns from buying at the opening price of the following session are shown in this table.
On average, the market has done slightly better following all-time highs than it has done at other times. This is especially true over 3 to 6 month horizons, where the average return has been some 0.4 and 0.6 per cent higher.
The likelihood of further gains is also greater following a new peak in the market. Once again, the most significant period has been the next 3 to 6 months. Over a three-month horizon, the S&P has gone up a bit more than 70 per cent of the time following a record reading, compared to only around 60 per cent for other three-month periods.
What about when the market has fallen in the wake of record highs? The accompanying table displays the average decline in the S&P at its lowest intraday level following an all-time high. In all cases, the market’s average worst falls were lower than at other times. One year later, for example, the average worst decline was 9.4% after a record high, against 11.9% at other times.
Of course, the drawback of averaging is that it can obscure some pretty extreme events. Therefore, I’ve also looked at the maximum peak-to-trough price declines suffered after the index made history on the upside. The worst 1-, 3-, 6-, and 12-month declines of all came after times other than record highs.
These results certainly suggest that new all-time highs are a reason to be optimistic, rather than cautious, about the outlook in the near future, particularly over 3 to 6 months. That being the case, there is every reason for tactically-minded investors to keep faith with the S&P’s bull market for now and to stay long.