S&P 500: a tale of two graphs

by George Hatjoullis

S&P indexsp500log

It is doom and gloom from equity pundits. They all seek a major correction or even a bear market. The arguments stand or fall on their own merits and nothing can be added that really adds light. I offer two charts of the S&P 500 going back to 1964. The first is a standard index level chart. The chart is dominated by the gyrations over the last 12 years and the rally since 2009 looks exponential and unsustainable. However there is an optical illusion at work in a levels charts that spans a long time period. A 10 point move in the S&P 500 when the index level is 100 is 10%. A 10 point move when the index level is 1800 is 0.56 of 1%. Not so much. The second chart adjusts for this optical illusion by plotting the log of the index. The chart is no longer dominated by the last 12 years. Moreover the bull market from 2009 is barely noticeable. Indeed, if you ignore the scale, what you see is a chart of a price in a long-term bull market that has just experienced a continuation pause. It has broken out of the ‘bull flag’ on the upside and resumed the uptrend. There is no reason to think that the trend will not continue for as long as the first leg, since 1964.

Surely there is more to it than a simple transformation of the data to a log scale? Of course there is much more to it. However, much of the doom and gloom is based on the optical illusion present in the first chart so the log transformation is important in getting the correct perspective. A slight change in perspective can result in a profoundly different understanding. Moreover, stock prices conform to a submartingale stochastic process so going up should be the natural order of things.In an economy with a positive growth of potential GDP and ever-expanding stock of money where else should stock prices go?