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Indicator of the Week: The Great Depression Signal That Just Recurred

Historically, when big daily SPX moves cancel out on a weekly basis, it's led to higher volatility going forward

Senior Quantitative Analyst
Dec 23, 2015 at 7:23 AM
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On the S&P 500 Index (SPX), two of the last three weeks have had four of five trading days in which the index has moved up or down by at least 1%, but the week as a whole moved less than 0.5%. In other words, big daily moves in one direction are quickly being canceled out by big daily moves in the opposite direction.

The last time we had such a week was in September 2011. In fact, since 1928, there have only been three other years with multiple signals -- 2008, and the depression years of 1930 and 1933. This week I'll take a look at what this has meant going forward. Also, a similar phenomenon has been happening over a longer time frame, which in the past has been a very ominous indicator.

Big Daily Moves, Flat Week
: As I mentioned above, last week and a couple weeks earlier the SPX saw at least four 1% daily moves in the week, but the week itself was flat (moved less than 0.5%). Since 1928, it's the 21st time this has happened. Below is a summary of the returns for the SPX going forward after such weeks.

The returns are bullish compared to typical weeks over the last 86 years. However, the numbers that stick out to me are the volatility figures. Looking at the three-month returns, the typical standard deviation is less than 10%. After the signals I just mentioned, though, the three-month standard deviation is over 22%. The volatility is also demonstrated in the average positive and average negative figures. Typically, in a three-month period, the index moves up or down by an average of 7%. However, after flat weeks with at least four 1% days, when the index is negative over the next three months, it's down by an average of 12%. If it's up, it's up by an average of 16.6%. According to this, it would not be surprising if we see significant volatility going forward.


Flat Market, Big Daily Moves, Near All-Time High: The weekly signal above is just a microcosm of what has been happening over a longer time frame. With the market near all-time highs, we've seen a relatively flat market over the past six months, but a significant number of 1% daily moves.

I went back to 1928 on the SPX and defined a signal as within 5% of an all-time high, trading within a 15% range over the past six months between the high and low, yet over those six months having at least 40 days in which the index moved by at least 1%. Below is a chart showing the signals since 1995. There were early signals in 1997/1998 and then more signals just before the tech bust. The next signals, in December 2007, were almost perfect sell signals, just before the housing bust. Hopefully, the recent signals don't play out similarly.


To quantify some results, I used the criteria above, but only considered one signal over a six-month period. Doing that (and going back to 1928), you get the signals shown in the table below. Besides the late 1990s and 2007 signals that I mentioned already, you also see a couple signals in the early 1980s. The 1981 signal led to a significant pullback of almost 20% over the next year. By contrast, the signal in 1983 was a good time to buy stocks. Meanwhile, the first signal is the most troublesome of all. It occurred in June 1929, less than three months before the stock market topped out and collapsed into the Great Depression.



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