Stocks ended the week on a high note, with the S&P 500 (SNPINDEX: ^GSPC ) and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI ) both gaining 0.5%. Despite these gains, the VIX (VOLATILITYINDICES: ^VIX ) edged up slightly but managed to close below 13.
Winning streaks and the market bestiary
For the S&P 500, Friday marked the eight consecutive day of positive performance, the longest winning streak since November 2004, when the index managed to string together nine straight "up" days. Over the long term, we know there is a positive "drift" to equity prices -- they tend to rise. However, if we assume that price changes are random over short periods and that the odds that the index will rise or fall on any given day are 50:50, then the probability of an eight-day win streak is the same as that of flipping heads with a fair coin on eight consecutive tosses. That number is equal to one-half raised to the eighth power, or:
(0.5) x (0.5) x (0.5) x (0.5) x (0.5) x (0.5) x (0.5) x (0.5) = 0.4%
Low odds, indeed, but bear in mind that a calendar year with 252 trading days contains 245 periods that are eight days long. In fact, since Jan. 1950, the S&P 500 has produced 51 streaks with length equal to or higher than eight days -- one every 15 months on average (the longest streak, 14 days, occurred in April 1971). In other words, what is remarkable is not so much that the index has just achieved an eight-day streak, but rather how long it has been since the previous one -- more than eight years. What can we draw from this?
The drought in streaks of this length may be attributable to the "risk-on, risk-off" regime that has governed market psychology in the aftermath of the credit crisis -- trend-following hedge funds have been struggling in the current environment. However, that doesn't cover the earlier part of the drought, between 2004 and 2008. One possible explanation: It's more difficult for the market to put together long winning streaks in the secular bear market that has been pawing investors since 2000.
On that line of reasoning, is the current streak an indication that the secular bear market has now ended (or is ending)? Perhaps, although on a cyclically adjusted basis, stock valuations look elevated for the start of a hypothetical bull market, which would put a heavy burden on earnings growth to carry stock prices higher. Either that or the secular bear market ended when valuations bottomed in March 2009 and we are already three years into the current cycle.
The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock it is in our brand-new free report: "The Motley Fool's Top Stock for 2013." I invite you to take a copy, free for a limited time. Just click here to access the report and find out the name of this under-the-radar company.