The S&P 500 Index has gained or lost at least 2% in eight of the past 10 weeks
A couple things happened this week that caught my eye. I noticed the weekly returns of the S&P 500 Index (SPX) were moving up or down significantly, and I found the 10-week average absolute return was moving above 3% for the first time since 2011. Also, it has been an eventful last few days.
Last Friday, the S&P 500 fell 2%, but then on Monday of this week, the index made up that back and then some. It's the first time the index erased a 2% loss in one day since, once again, 2011. Does this mean volatility is coming back? This week, I will look at how stocks behaved after these signals.
Traders Should Brace for More Volatility Ahead
The S&P 500 is making some significant moves from week to week. The index has gained or lost at least 2% in eight of the past 10 weeks. In fact, the average 10-week absolute return of the index is above 3% for the first time since 2011. Perhaps this sign of creeping volatility means something?
Since 1929 -- as far back as we have S&P 500 data -- I found each time the 10-week average absolute return spent at least a year below 3%, and then moved above that level. This has the 15th time we’ve seen it, and the table below summarizes the returns after these occurrences.
Focusing on volatility, it looks like there is some heightened volatility in the short term after these signals. The standard deviation is significantly higher in the first few months after a signal, but when you look out one year, the volatility is close to normal. Typically, higher volatility correlates with lower returns. However, this is not the case after these signals. The index outperforms after these 14 instances when looking at average return.
A lot of times, the signals happened when stocks went into a strong downtrend. To get signals most closely like our current environment, the table below only considers signals when the S&P was higher over the previous 12 months. In those instances, the returns have been even more bullish. Again, the volatility is again higher in the short term.
Another Stock Market Signal Not Seen Since 2011
Here’s something else that recently occurred for the first time since 2011. Last Friday, March 23, the SPX fell 2.1%, but then the next trading day, Monday, the index made that back and more. This is a relatively rare event, being only the 20th such occurrence since 1950 (I wanted to disregard the Great Depression, where these events were common).
The table below summarizes the returns after these instances, while the table below that shows typical returns since 1957, the year of the first occurrence. The short-term returns from one week to three months shows underperformance. In the month after a signal, fewer than half of the returns were positive, averaging a return of just 0.37%. When you get to six months after a signal, the underperformance disappears and the price action becomes bullish. This study, just like the one above, points to increased short-term volatility, as measured by the standard deviation of the returns.
