On July 22, the S&P 500 (SPY) closed at another record high, its 47th of the year. We may find ourselves asking where the markets will go now. Just as we may have asked in the 46 record closes that preceded it. Will we extend to another record close? Or will we retrench?
We can look for clues in another similar time period when investors and policy officials were asking similar questions. Let's go back nearly 17 years, to December 5, 1996. Then Federal Reserve chairperson Alan Greenspan commented on a similar quandary concerning rising asset prices. He used what became the (in)famous phrase "irrational exuberance", when questioning the source of escalating asset prices.
So how does the recent record streaks contrast with similar measures from 1996? We find that in some respects the current market's record setting highs appear more jumpy and less "expected," As one might deduce from the still unknown conclusion of an unprecedented monetary-engineered activity.
The current record closing streaks started 233 trading days before, in August 2012. So let's examine the two 233 trading days before both events, in the illustration below. In blue we have the stretch leading up to Alan Greenspan's "irrational exuberance" comments. In red we have the stretch leading up to the most recent record close in July 2013. We notice, for example, that 10 days prior to Alan Greenspan's comments, the S&P had closed for a 6th straight record close.
On the surface not much looks different between the two time periods. After all, they both have the same peak streak of 6 record straight closes. But a more relevant econometric measure to look at for both periods is the portion of trading days that were record closes. This portion in 1996 was just 16%, while more recently in 2013 it is 24%. Clearly the current environment is providing more opportunities to easily achieve these record-closing streaks.
However, an important missing component to this analysis, which helps us understand the difference between the recent market performance and that for 1996's "irrational exuberance" performance, is the variation in the streak performance during the periods. During 1996 this variation was slightly less, implying that record trading days that initiated any streak were steadier and more of a given. Despite implied volatility indicators being similar both now versus then, recent market participants are this time more weary of a pullback, speculating that the liquidity-driven rally will support against a market retrenchment.
We then have calculated statistical ratios of the portion of record days to variation in streaks. This assists in quantitatively measuring the performance in record streaks, adjusted for variational errors. And the statistical ratio is higher values now (21%) versus in 1996 (17%). So this adjusted indicator is registering a high degree of upward bias in the markets, even adjusting for variational risk, versus the "irrational exuberance" period. Things indeed are much different this time.
As an epilogue, we note that roughly two quarters after Alan Greenspan's 1996 comments, the markets had a substantial correction, but then proceeded to form a much higher technology bubble peak that defined the times. From a statistical perspective of analyzing this recent market performance, it appears that the S&P 500 has more room to rise before a downward pathway. Just as long as the Federal Reserve does not taper its accommodative easing policy.