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Do new stock-market highs herald future gains?

Mark Hulbert tests the new narrative that after hitting another all-time high, the market then performs better than it does on other days.

What can we glean about the future from the new all-time high at which the Nasdaq Composite Index closed on Monday, or the new all-time high registered by the S&P 500 last week?

Next to nothing, it turns out.

It’s important to point this out in order to counter an emerging narrative on Wall Street. That story holds that, in the wake of hitting a new all-time high, the stock market on average performs better than it does on other days.

It certainly would be nice if things worked out that way. It would mean that investors would be justified in the euphoria that many currently are feeling.

Try as I might, however, I could find no statistical support for this narrative. And I did try. I segregated all trading days in recent decades into two groups: Those on which the Dow Jones Industrial Average hit a new all-time high, and those on which it didn’t. For each group, I calculated the DJIA’s average return over the subsequent month, quarter, six months and year.

What I found is plotted in the accompanying chart. Notice that for the month, quarter and six-month time frames, the DJIA on average performed better in the wake of days in which it did not hit an all-time high. Only at the one-year time frame was the DJIA’s average return higher following days in which it hit a new high.

Before you try drawing any conclusions from these differences that are plotted in the chart, however, you should know that none of them is significant at the 95% confidence level that statisticians often use when determining if a pattern is genuine.

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Hulbert Chart 082520

Though you might find this conclusion discouraging, I don’t think it is. On the contrary, the stock market would be even more volatile than it already is if its behavior was dependent on how it had performed in the past. A hallmark of an efficient market is that its level at any given time reflects all available information up to that point. This enables it to have a single-minded focus on the future.

That’s its job, after all. It’s supposed to discount the future. The stock market’s return in coming months will be above-average if things turn out to be better than is currently anticipated, and below-average if things turn out worse.

This is a subtle but crucial point that is easily misunderstood. The stock market doesn’t react to how good or bad corporate profits are in an absolute sense but to whether those profits are better or worse than previously anticipated.

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With my clients I often use a horse-racing analogy to make this point: Imagine a 10-horse race in which we are allowed to bet on any finisher, and that one horse is the overwhelming favorite while another is expected to come in dead last. Imagine further that the favorite horse finishes second, while the horse that was expected to come in last instead finishes seventh.

It’s entirely possible that you would make more money having bet on the horse that came in seventh than the one that came in second — even though the second-place horse was a far faster horse.

The bottom line? Both in theory and in reality, following a new all-time high, the stock market’s odds of rising are no better or worse than they are at any other time.