​As Sam Sees It: Why Investors Should Not Monkey Around in the Face of Volatile Markets

Sam Stovall |

Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.

EQ: Fed Chair Janet Yellen is speaking in front of Congress this week for her semi-annual testimony. By most accounts, her tone on the economic growth is a bit more on the cautious side. What were some takeaways on her first day for you?

Stovall: I think first off she didn’t want to budge on tipping her policy hand in response to questions about the deterioration in the global stock markets. Also, she said they will be focusing on the data, basically saying that they’re going to do what the data tells them they need to do. They are still focusing on recalibrating rates toward inflation, but at the same time she did suggest that low inflation remains a concern, and certainly, that could help to decide whether she takes a slower path to recalibration than what was originally estimated.

EQ: We’re about a month away from the bull market’s seventh birthday. What’s the likelihood that we’re going to make it there?

Stovall: Well, I think the jury is still out. We peaked a good eight months ago in the end of May, and typically, bear markets take nine months on average to go from the peak to the 20% decline threshold. So if this ends up being a bear market, and it ends up acting similarly to the average bear markets since World War II, then we’ll probably cross into bear market mode by the end of this month. But there have been many other corrections that have turned around just before eclipsing that 20% decline threshold, so really, the jury is out as to whether it will end up moving from the correction mode into the bear market mode.

EQ: So the level to watch would be around the 1700 level, which would be about an 8.5% decline from current levels?

Stovall: I like to look at things on a closing basis, which would be about 1705 on the S&P 500, but there’s no need to quibble over a couple of points. If we get down that low, it certainly is going to feel like a bear market. But I have to remind investors that looking at corrections since WWII, the most recent low was 264 days after the all-time high. Whenever we’ve gone more than 200 days before bottoming in a correction, it’s taken a similar amount of time to get back to break even—anywhere from four to seven months, whether you’re looking at the mean or median. So it’s not going to be something that’s going to happen overnight, but it’s probably going to be a lot quicker than people expect. That’s why I continuously urge investors to not become their worst enemies by bailing out at the bottom.

EQ: After years of enjoying a low-volatility environment, the market has seen a spike in the number of days in which the market moves 1% or more in either direction. We discussed before how the market behaves around a rate hike. Is this in line with what your expectations were?

Stovall: Yes, it is. We find that traditionally we have close to 17 days in which the market rises or falls by 1% or more in the three months after the Fed has started to raise interest rates. That’s compared with an average of 9.3 days of volatility in the three months before the first rate increase. So it’s about an 80% increase in volatility by that measurement just in the subsequent three-month period. Since the Dec. 16 rate increase through Feb. 5—essentially in less than two months’ time--we’ve already had 20 days in which the market rose or fell by more than 1%. In fact, we’ve had 16 days since this year began. If we were to annualize that, we would have 157 days of volatility, which would be the greatest number of 1% days in a particular calendar year since 2000. That therefore includes the Tech bubble bursting in the early 2000s, as well as the Financial Crisis in the late 2000s. So if this volatility pace continues, it will be a record year.

EQ: What does this heightened volatility tell us about the market going forward? Do you expect it to continue to increase?

Stovall: I’m glad you asked that because I think in many ways bull markets are like humans in that they get increasingly unstable as they age. So I looked back to WWII to see how many days on average where we had 1%-plus volatility in the first year, second year, third year, and all the way out to year nine of bull markets. Remember, we’re in year seven now, but on average we ended up with 55 such days as compared with only 43 days in year six. But as we move to years eight and nine, we’ve had 85 and 95 such days. So volatility tends to increase. Of course, the number of observations—meaning the number of bull markets that have lasted this long—gets smaller and smaller. By the time we get to year nine, only one bull market since WWII went that long. But still, it’s a very upward-sloping line when you look to the trough in year three and then work your way up to the peak in year nine.

EQ: February 8th marked the beginning of the Year of the Monkey on the Lunar Calendar, which has historically been pretty good for investors with an average gain of 7.8% for the market and a frequency of advance of 100%. Those are pretty impressive numbers. How much weight should we put into it?

Stovall: I think we put as much weight into these numbers as we put into the Super Bowl Theory (which by the way is negative since the Denver Broncos of the AFC won). I just figured that so many people were going ape over the Super Bowl Theory that investors would be interested in hearing how the Year of the Monkey turned out. As you noted, it’s pretty good price performance, so I figured investors would be equally intrigued by this similarly non-causational indicator that hints encouragingly that 2016 might not be so bad a year for stocks after all.

For more from S&P Capital IQ, be sure to visit www.getmarketscope.com.

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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