Stock Signal Also Flashed in 1929 and 1987

The last time this volatility alarm sounded was Black Monday

Oct 29, 2018 at 2:33 PM
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It's been a rocky month for the stock market, to say the least. The S&P 500 Index (SPX) briefly flirted with correction territory last week, and is on pace for its worst month since May 2010. What's more, over the past 20 sessions, SPX's 20-day historical volatility (HV) skyrocketed more than 300% -- from 5.48 on Sept. 28 to 22.41 on Friday, Oct. 26. This volatility signal has flashed just eight times in history, according to Schaeffer's Quantitative Analyst Chris Prybal -- and it's aligned with some big stock market crashes.

In fact, the last time S&P 500 HV surged at least 300% in 20 trading days was Oct. 19, 1987 -- otherwise known as Black Monday. Plus, looking at only one signal per every 30 days, this same surge in HVs occurred in May 1940, when Hitler was sweeping across Europe. It flashed for the first time ever on Oct. 30, 1929, as stock prices plummeted in the midst of the "Great Crash" that preceded the Great Depression.

After the 1987 signal, stocks actually went on to deliver healthy returns. Two weeks later, the S&P was back up 13.6%, and was up 15.2% four months later. In fact, the total return for 1987 -- including Black Monday -- was 5.81%, per Prybal. Looking even closer, the SPX was higher three, four, and six months after all signals, with the exception of 1948.

SPX after HV signals 3

Looking at all signals, selling tended to beget selling -- at least over the next week. On average, the SPX was down another 1% after volatility signals, compared to an average anytime one-week gain of 0.1%, looking at data since 1928. Two weeks later, the index was down 0.2%, compared to an average anytime return of 0.3%.

However, starting one month after signals, the S&P outperformed. Specifically, a month later, the index was up 2.8%, and higher 86% of the time. That's compared to an average anytime one-month gain of 0.6%, with a win rate of just 60%. Six months later, the SPX was also higher 86% of the time, as alluded to earlier, and averaged a gain of 8.9% -- more than double its average anytime six-month gain.

It's also worth noting that the SPX was less volatile than usual a month-plus after signals. This, per the Standard Deviation rows in the chart below. But, as Schaeffer's Senior V.P. of Research Todd Salamone pointed out in this week's Monday Morning Outlook, whenever large speculators in Cboe Volatility Index (VIX) futures have "moved into a net long position, which they are close to doing, it is not only rare, but it comes at peaks in volatility. The action in the [Commitments of Traders] report is one of the stronger cases one can make about volatility being at or very near a peak."

SPX after HV signals vs anytime


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