Breaking Down the Quick & Dirty S&P Drop

Hotter-than-usual volatility could continue into 2019, if history repeats

Dec 18, 2018 at 1:10 PM
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The major stock market indexes are in correction territory -- defined as at least 10% below their record highs -- and the S&P 500 Index (SPX) is no exception. In fact, the broad-market index fell more than 11% in just 50 sessions, marking the first time the index has dropped at least 10% in that short of a span since January 2016. Below is what we might expect for the S&P going forward, if past is prologue.

Going back to 2000, there have been 14 of these signals, allowing just one signal per quarter, according to Schaeffer's Quantitative Analyst Chris Prybal. Prior to the early 2016 pullback, the last time the SPX made such a fast correction was in August 2015, around the time of the "flash crash." That marked the first signal in four years.

SPX after quick corrections since 2000

As you can see on the chart above, stocks recovered nicely after corrections since the January 2009 signal, which preceded the March 2009 bottom. Three months after the last fast retreat, the S&P was up 11.4%. The last time the index was negative three months after a quick correction was back in 2008, during the throes of the financial crisis.

Since 2000, when the S&P has dropped at least 10% in 50 sessions, the index has experienced more short-term speed bumps. One week later, the SPX was down 0.7%, on average, and higher just 36% of the time. That's compared to an average anytime one-week gain of 0.1%, looking at data since 2000. The SPX averaged a loss at both the two-week and one-month checkpoints, too, compared to average anytime gains.

However, stocks begin to recover by the two-month marker. Two months after a relatively fast correction, the SPX was up 1.1%, on average -- slightly better than its anytime returns. Three months later, the index was 2.2% higher, on average, and up 71% of the time, compared to an average anytime three-month gain of 1.2% with a 64% win rate. And again, the three-month returns after a correction would be even stronger, if not for steep drops after the signals in 2008 and 2002.


SPX after quick correction vs anytime

The current volatile backdrop could continue well into 2019, though, comparing Standard Deviation stats above. This, even though the Cboe Volatility Index (VIX) averaged losses at all checkpoints following a quick SPX correction, and was higher less than 40% of the time across the board. This suggests that even though SPX volatility tends to run hotter than usual after corrections, volatility expectations tend to decline.

VIX after SPX correction


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