Digging into the implications of V-bottoms for the SPX
In less than four months, the S&P 500 Index (SPX) hit an all-time high, dropped more than 15% and has now rebounded to within striking distance of that high. This quick decline and recovery have formed what’s known as a V-bottom. The chart below makes it clear where that name comes from.
In anticipation of approaching this all-time high, I’ll examine how the S&P 500 typically behaves when the high looms overhead. Then, I’ll narrow the focus to V-bottoms, as I define them, to see if that changes the implications of what we find.
SPX Near Highs
Going back to 1950, I found times the SPX pulled back at least 10%, then moved to within a hair of the all-time high (specifically, within 0.2%). I was curious if the all-time high looming overhead acted as potential resistance. The data below shows evidence of this. In the 20 instances of the SPX trading near its all-time high after a significant pullback, it averaged a loss of 0.27% over the next month.
The three-month average return of 1.33% also underperforms its typical return, despite 80% of the returns being positive. This, along with the meek average positive return of just 2.84%, indicates the index stalling and tending to trade sideways for that three-month period. Longer term investors, have less to worry about as the six- and 12-month returns are close to typical returns.
As I mentioned earlier, the current chart shows an especially rapid decrease and rise, making a V-bottom. To see if this changes anything, I took all the signals from the data above and found seven where the decline and rally happened within a seven-month period (this seemed like a good cutoff since all other decline/rise signals took at least 13 months). The table below summarizes the index returns after these signals.
The short-term returns are slightly worse in these instances. We still see a negative one-month average return but now with just under half of the returns positive. The three-month average returns fell to a loss of 0.66% and the percentage of positive returns for that period went from 80% in the table above to now just 57%. Again, the longer-term returns are less affected.
This last table shows the seven instances of a V-bottom for the SPX since 1950. The last time was the rally after the Covid-19 pandemic, in which the index gained over 30% over the next year. As mentioned above, the index was higher every time in the next month. However, in the short-term, the all-time high may have been significant resistance, with the index down over 1% in the first month after a signal. After two of the past three V-bottoms, the SPX struggled not only in the short-term but in the longer term as well, with negative returns a year later.
