A Little Context for This Market Volatility

Newfound Research |

With S&P 500 futures down -3.2% at the time of writing, we wanted to put some thoughts together to give some context to the recent sell-off.

We'll start with a picture... here are historic drawdowns in the S&P 500 (blue) and the current drawdown (orange):



So how bad was last week?

  • Last week’s decline in the S&P 500 was the 32nd worst weekly loss since February 1950. The empirical probability of seeing such a loss is 0.80%.

What does that mean for this week?

  • Of those 32 weeks, only 44% were followed by a subsequent negative week. The average return of the week following such a sell-off is approximately -3% (which has already been exceeded as we write this). But we might see more panic selling this week – especially after piercing the 200-day moving average.

And the long term?

  • However, the 1-month return after these 31 sell-offs was, on average, +1.29%. Meaning that despite initial panic selling, the market, on average, has tended to mean-revert over the following weeks.
     
  • As of Friday, the S&P 500 was in a 7.5% drawdown. Since February 1950, such a drawdown has been exceeded 30 times. Of those 30 times, only 9 went on to be drawdowns exceeding 20% and only 5 exceeded 30%.

What's our take?

  • A healthy market requires corrections. If we knew the market never would never go down, prices for stocks would be infinite (because if they are always going up, no price is too high to buy!). Volatility is just the price we pay to participate in financial markets. Having a plan, and sticking to it, is critical in times of volatility.
     
  • Markets can mean-revert very quickly. One needs to look no further than October 2014. From September 18, 2014 to October 16, 2014, the SPDR S&P 500 ETF (SPY) was down 7.3% in 20 days. For comparison, SPY is currently down 7.1% in the last 24 days. In October 2014, SPY rocketed back from the bottom to reach a new all-time high just 11 days later.
     
  • Drawdowns tend to take time. Those exceeding 20% in depth were, on average, 1.28 years in length from peak to trough.
     
  • Is this just a correction or the start of the next bear market? Only time will tell. But we believe high velocity moves like the ones we are experiencing are a reminder that having a plan before panic sets in is critical to long-term performance and risk-management success.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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