A feeling of vertigo may seem natural as Wall Street approaches a record and stock markets around the world climb to their highest levels since 2007. With the Standard & Poor’s 500-stock index now only 0.5 percent away from its 2007 high of 1565 and with the Dow Jones industrial average scaling new peaks almost daily, what will investors expect to see when they reach the mountaintop? The mountaineering analogy suggests, at best, a long descent and, at worst, a precipitous drop. But how literally should we take such metaphors?
Bearish analysts often claim that stock market peaks have always been followed by sharp falls, citing as evidence the record high of October 2007, which was quickly followed by a 57 percent collapse in 2008-09. They add that the previous peak, in March 2000, was followed by a 37 percent plunge and that last major high before that, in August 1987, preceded the biggest-ever market crash, in October 1987. These precedents, along with the even more vertiginous peaks of 1989 in Japan and 1929 on Wall Street, certainly sound scary, but they are meaningless.
It may be true that all major market peaks have been followed by big declines, but the reason is semantics, not finance or economics. A peak is, by definition, a high point followed by a decline. A new market high that is not followed by a fall in prices is simply not called a peak. A record of this kind, far from preceding a steep decline, tends to act as a staging post for higher prices. Looking back through history, it turns out that this benign type of record, paving the way for higher prices, is actually the norm.
There have been eight occasions in the past 100 years when stock prices on Wall Street, as gauged by the S&P 500 or its predecessor benchmarks, have broken through to significant new highs, defined for the purpose of this analysis as a breach of previous records by 3 percent or more: December 1924, September 1954, September 1963, August 1967, May 1972, July 1980, November 1982 and July 1989. All these record highs were followed by further price gains, and none experienced a significant decline for at least six months.
This history starts in 1924, when Wall Street broke out of a 10-year bear market that started before the World War One. After December 1924, when stock prices finally managed to break through their prewar peak, the stock market immediately advanced by a further 23 percent in the next 12 months. It then accelerated and soared much higher, gaining a total of 216 percent. It was only five years later, in September 1929, that stock prices hit a peak in the mountaineering sense, followed by the greatest bear market of all time.
