Indicator of the Week: Why This Volatility Signal Conjures Up Memories of 1987

The S&P 500 Index (SPX) dropped more than 2% in three straight days for the first time in roughly 13 years

Senior Quantitative Analyst
Aug 26, 2015 at 6:45 AM
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This week I'll obviously be talking about the stock market plunge that began last week and continued on Monday. The S&P 500 Index (SPX) fell by more than 2% last Thursday, then fell by more than 3% on both Friday and Monday. It's the first time in about 13 years the index has fallen by 2% or more three days in a row. This week, I'll examine all the times this has occurred and how the market reacted going forward. 

Three Straight 2% Down Days: For the first time since 2002, the S&P 500 suffered three straight down days of 2% or more. This has happened 13 other times since we have data on the index (since 1928). Below is a complete list of those occurrences, along with some other stats. You can see the large majority of them occurred during the Great Depression, so I’m not sure how relative those are to the recent signal since, at least as of now, we’re not in a depression.  

One thing that stands out about the recent plunge is its proximity to the SPX's all-time high. Before the three 2% down days, the S&P 500 Index was just 2.4% away from its all-time closing high. The only other signal close to that was on Oct. 16, 1987, which happened when the index was just 6.6% away from its all-time high. Eerily, the next trading day after that was Oct. 19 -- Black Monday -- when the index suffered its biggest one-day drop ever, losing over 20%. Thankfully, yesterday wasn’t a repeat of that

 

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Below I summarized the returns in the table above and compared them to typical returns since 1929. To say the prior instances have typically led to outperformance or underperformance seems kind of pointless, because the main takeaway for me was the increased volatility going forward.

For example, in the week after a signal, the S&P 500 averaged a gain of just 0.08%. In other words, on average it was essentially flat, but there is no way, judging by the data, you would expect a flat market. When it went up, it went up a lot (an average gain of 8.74%), and when it went down, it went down a lot (an average loss of 7.34%). Again, keep in mind a majority of the returns in that first table happened during the Great Depression, so I'm not very confident that it accurately reflects the current environment. 


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