S&P 500's All-Time Highs: Buy Or Bye?

by: Dominic Picarda, CFA


The S&P 500 and Germany's DAX are at record highs.

Momentum traders claim this is bullish, while some longer-term investors are nervous.

History suggests new highs are positive, even when adjusted for today's lofty US valuations.

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 of 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 ongoing 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?

Buy or bye at the highs?

Source: Investors Chronicle

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.

% returns

1m later

3m later 6m later 12m later
All-time highs 0.57 2.13 4.09 7.75
All other times 0.54 1.73 3.49 7.25

Source: Investors Chronicle

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 generally 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.

% probability of gains from 1m later 3m later 6m later 12m later
All-time highs 57.5 69.8 70.4 68.3
All other times 58.5 60.4 63.9 67.2

Source: Investors Chronicle

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.

Average worst loss (%) Within 1m Within 3m Within 6m Within 12m
All-time highs -2.63 -4.74 -6.33 -9.36
All other times -3.53 -6.19 -8.73 -11.95

Source: Investors Chronicle

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 after record highs.

Worst drawdown (%) Within 1m Within 3m Within 6m Within 12m
All-time highs -10.8 -44.5 -44.5 -45.7
All other times -32.7 -46.5 -52.3 -70.8

Source: Investors Chronicle

Admittedly, record price highs do not necessarily tell us anything about the value inherent in the market at those levels. My preferred measure of valuation is the Cyclically Adjusted Price Earnings ratio (CAPE), which compares the S&P 500 to its ten-year real EPS, and which I have found to be more predictive of subsequent real total returns than many other popular metrics.

Today, the S&P 500 trades on more than 25 times its average inflation-adjusted earnings of the last decade. That is well above its historic mean and median ratings of 16.5 and 15.9 respectively. At past price highs, it has variously traded on ratings of less than 10.6 and greater than 30. How has this impacted subsequent return performance?

Logic suggests that the best of all worlds would be a combination of all-time highs and a low or modest CAPE. I have therefore sorted the one-year returns following a record index-peak according to their valuations at those price peaks. As it turns out, all-time highs accompanied by cheapness are associated with further price gains over a one-year view. So far, so good.

CAPE Ave 1yr return (%) Gain prob (%) Ave worst loss (%)
5.6-10.6 4.4 61.5 -6.1
10.6-15.6 25.5 100.0 -4.8
15.6-20.6 3.0 57.1 -9.2
20.6-25.6 7.9 73.2 -8.1
25.5-30.6 11.5 62.5 -15.0
30.6-35.6 11.7 75.0 -14.4
35.6-40.6 17.4 100.0 -11.9
40.6-45.6 -1.6 50.0 -12.7

Source: Robert Shiller

As it turns out, though, record price highs alongside lofty valuations like today's have not been associated with poor one-year returns to come, except when CAPE hit unprecedented levels above 40.6 at the height of the internet mania. Based on history, therefore, there is a decent chance of low decent double-digit price-returns on a twelve-month view.

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 the next 3 to 6 months. This is therefore one reason for tactically-minded investors to keep faith with the S&P's bull market for now and to stay long.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.