This commentary is available as a PDF here.
- We’ve heard from several market participants that they feel that markets have “gotten faster” lately.
- We define two quantitative measures of speed and examine how speed has evolved since the 1920s
- We demonstrate that market speed is actually well within normal ranges – but perhaps our perception of normal has changed with the extremely high risk-adjusted return earned in U.S. markets since 2009.
Are markets getting faster?
That’s a common question we receive. There appears to be a general market feeling that market events are unfolding faster than ever – that to keep up, investors must act faster and trade faster.
Some investors we’ve spoken to posit that it is high frequency trading speeding things up. Others argue it is the increase of systematic investment methodologies, driving price swings to unnatural extremes. Others argue that a structural shift in investor risk-aversion post 2008 causes elevated levels of panic.
None of these arguments given, however, are easily quantitatively proven. They are gutfeelings that come with little-to-no evidence.
To actually test if markets are getting faster, we need to come up with a measurement of speed. What we believe most people mean when they say markets are getting faster is that prices are covering a greater distance in a shorter amount of time.
To systematize this idea, we identified local price highs and lows using a 10-day simple moving average. Local extreme points are identified every time price crosses above or below the moving average. The distance covered between these extreme points, and the time it takes to cover that distance, is how we will measure speed.
Using market data from the Kenneth French library (NB: this is a total market measure, not just large caps), we can then find the average daily speed per quarter going back to 1926 and plot it to determine if markets have been moving at a faster pace. The answer?
Perhaps averages aren’t the right measure. Maybe we have to look at the extremes and ask, “are they getting more extreme?” So we can plot the maximum speed, per quarter, as well.
Certainly higher, but not unusually high. 2011 was actually worse.
So perhaps we have the wrong measure. Perhaps it is not the speed of the drawdowns, but rather the number of large drawdowns themselves.
So let’s plot the number of days in between 10% drawdowns. If drawdowns are happening faster, we should see fewer days between them.
What do we see? As it turns out, we just went through an incredibly prolonged period of no 10% drawdowns. August 2015 broke an 800+ trading day streak.
If anything, we just proved the opposite.
What if we take a broader view of drawdowns, though? What if it isn’t just about the magnitude, but also the frequency? We can use a measure called the Ulcer Index to quantify that! (In this case, we’ll use a 252-day lookback).
Yet once again, we can see that we’re much closer to all-time lows that all-time highs.
Another way to look at this data is to look at the number of significant price swings we’ve had over some trailing period. Below we plot the number of 10% swings (whether positive or negative) over rolling 3-year periods. We see a significant drop-off after 2011 (once 2008 falls out of the picture) and a continued decline to historically low levels.
The four 10% up/down moves over the last 3 years is less than half the long-term average.
Now, for momentum-based models such as our own, not all 10% moves are made equal. Seeing a number of 10% moves up in a row is much better than seeing reversing moves up and down, causing a choppy sideways market. So one way we can evaluate the environment the consistency of these moves is by looking at a running total. We add +1 when there is a positive 10% move and -1 when there is a -10% move.
Time-series momentum users will want this line to either be going up or down consistently.
We believe the cumulative trend is still exhibiting very normal behavior.
So what’s going on here? We would posit that investors are conditioned by their environment – and the recent environment has been easy. How easy?
Source: Kenneth French Data Library. Analysis: Newfound Reesarch.
From 3/16/2009 to 12/31/2015, the market exhibited a realized Sharpe ratio of 1.06. By comparison, the long-run Sharpe ratio of the market from 1926 through 2015 is 0.36.
Compared to other 1712 trading-day periods, that puts the recent bull market in the top quintile – outdone only by the dot-com boom and the post-World War II boom.
Markets aren’t getting faster; we’ve probably just been lulled into a false sense of security lately.