Two and a half weeks ago, the stock market looked invincible. The S&P 500 Index had just closed at an all-time high of 2,480.91 on August 7th, and even more impressive, it got there with remarkably low volatility. Over the previous five years, the stock index had risen over +75%, and in that time, there had been only eight discrete declines of -5% or worse – “discrete” meaning they were separated by a move higher of at least +5%. That means the S&P 500, on average, went more than seven months before seeing a -5% or larger fall.
Let’s put that in perspective. From 1990 through 2010, the S&P 500 suffered such a fall roughly every three months – more than twice as often as investors have been used to recently. Compared to historical standards, it’s safe to say that this ride up has been unusually smooth over the past few years. That has been especially true of late. The stock index has gone over a year without facing any sizable declines, and in fact, the last time it saw even a -5% drop was all the way back in June 2016, when the current uptrend began.
As of Tuesday’s close, the S&P 500 is still just -1.1% below its all-time high, despite a single-day slide of -1.45% earlier this month and an even larger -1.54% one-day drop last week. It’s clear, however, that this calm in the stock market cannot continue forever. The question that investors must now ask themselves is what will happen when the dam breaks. It’s been over a year since the S&P 500 last saw a -5% decline. Has selling pressure built up over that time, and more importantly, is the stock market primed for a major collapse?
Well, historically-speaking, it’s unlikely. Before the current uptrend, there had been six discrete periods since 1950 that the S&P 500 went longer than a year without falling -5% or more. Only one of them ended in a fall worse than -10% before the stock index began moving back up to retake its previous high. The other five times averaged a -7.7% decline. If the August 7th close of 2,480.91 does turn out to be the high of the current run-up, then investors can expect the S&P 500 to hit a low of roughly 2,290 before it begins to retrace its losses.
But it’s no certainty that the stock index did peak on August 7th. It’s possible that the current uptrend remains intact and that the S&P 500 will continue its calm rise to new all-time highs. It could be weeks or even months before investors find themselves facing the next -5% decline. In fact, the previous six uptrends that lasted more than one year have – for the most part – been longer and stronger than the current one being enjoyed by investors. On average, those six lasted 344 trading days and pushed the S&P 500 up 43% before finally seeing a -5% decline. If the current uptrend did peak on August 7th, it would have lasted only 291 trading days and amassed a price gain of only 24%, both far below average.
What exactly does that mean for investors? Well, by historical standards, the S&P 500 probably has some room left to run. Despite a couple blips in August, the stock index should see new all-time highs before it finally succumbs to a -5% decline. But if the August 7th close does turn out to be the high of this uptrend, it’s likely that the fall to follow will only be a modest one. So, is a stock market collapse coming? No – at least not yet.
K. Wes Lau is an independent investment research analyst based in Philadelphia.
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