What Does the SPX Pullback Mean for Stocks?

The SPX crossed the 5% pullback level for the first time in over 12 months

Senior Quantitative Analyst
Oct 6, 2021 at 8:00 AM
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Last Thursday, the S&P 500 Index (SPX) closed more than 5% below its early September all-time high. This also marked the first time the index crossed the 5% pullback level in more than a year. This week, I am diving into how stocks usually behave after a 5% dip, considering this hasn’t happened in quite some time. I will also look at historical data to determine what the chances are that the next level for the stock market is the 10% correction level, or a new all-time high.

Similar Pullbacks Since 1950

Going back to 1950, this was the 60th time the SPX pulled back 5% from an all-time high. The first table below summarizes the returns after these pullbacks, while the second table shows typical returns. The index has typically fared well in the short term following these pullbacks, averaging a 2% gain over the next month, with positive returns more than 80% of the time. Normally, stocks gain about 0.75% over this timeframe, with just over 60% positive returns. For buy and hold investors alike, these pullbacks could mean nothing, as the longer-term stock returns after pullbacks resemble the usual returns.

IOTW 1

Next, I isolated the 5% pullbacks that were the first to happen in at least one year, and summarized the returns in the table below. The second table shows the other pullbacks, which occurred within one year of the last 5% pullback. On a positive note, the SPX has usually performed well after these initial troughs. What stands out to me, however, is that this could indicate a short-term floor. The three-month returns were positive 14 out of 16 times, but the two times they were down over that time frame, the biggest loss was just over 1%. Again, the most outperformance happens in the short term.

IOTW 2

Many pundits consider a 10% pullback a technical correction. Once the SPX falls 5%, I wondered what the next level might be between an all-time high and correction territory. Looking at the 16 times the index pulled back 5% for the first time in one year, it reached a new high before hitting the 10% pullback level 75% of the time. It continued to lower to hit correction territory just 25% of the time.

Out of the 43 times the index pulled back and was within one year of the last pullback, the SPX reached a new high 58% of the time, before falling to correction territory. That means the index fell into correction territory 42% of the time, before reaching a new all-time high.

Historically speaking, since this is the first pullback in a long time, there is a 75% chance the SPX could hit a fresh all-time high. The next pullback, if it happens within the next 12 months, suggests a 58% chance of a new all-time high, compared to a 42% chance of becoming a correction. Again, these initial pullbacks are usually followed by strong returns in the short term.

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