Broker Check

Not so Fast

| March 16, 2020
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The past few weeks have brought about some of the wildest price action in a long time. The other day while grabbing my morning coffee, the barista asked me if she should be worried. She mentioned reading a headline that said something along the lines of, "This hasn't happened since..." These headlines go both ways, and at times like these there will be of flurry of them. It's been a constant onslaught of shocking news. The stock market hates the unknown and is currently trying to price in the magnitude of what may be to come.

These swings have been violent in both directions. On Thursday, March 12, 2020, the S&P 500 closed lower by 9.5%, marking the worst single-day decline since the 1987 crash. This was immediately followed on Friday with a gain of 9.29%, making it the best single-day gain since the Great Financial Crisis (GFC).

We live in unprecedented times and the market does a great job at making participants think the worst is over or the worst is yet to come. After such an amazing rally, one can easily think the coast is all clear. It feels good to see the market bounce hard and see an account statement displaying positive returns on the day. However, most likely the market has more than a few tricks up its sleeve and volatility isn’t going to suddenly disappear after one positive day.

I'm a student of market history. I always like to go back and study the past to see if such price action has previously occurred. If so, what were the forward returns of past events? There's no guarantee that things will play out as they did in the past, but it helps to show some possibilities. It displays how people reacted during those prior events.

I decided to test how many times the market has had a single-day gain of 9% or more. This isn't some unique idea. I'm sure many ran this same test after the market closed on Friday. In the following image, going back to 1950, all occurrences of a single-day gain of 9% or more are marked by the blue dots. As we see, this is something that is characteristic of a bear market rally. The only prior occurrences were during the crash of 1987 and the GFC of 2008, while we were already in a downtrend.

 

Yes, I know, maybe this time is different. And I'd also point out that the sample size is very small. You can only tell so much from something that has rarely occurred. I further wanted to study those prior events and see what the forward returns looked like after those massive rallies.

I looked at the returns that followed all three prior events. The following image plots the 30 days preceding and the 60 days following for each occurrence. The market struggled over the next 60 days following the prior occasions. Although, when I looked at 1-year forward returns (not pictured), all three were positive. But I'm more focused on what may take place over the next week or month, not year.

 

Furthermore, just to display how unique this past week’s price action was, I tested how many times the market had a 9% or greater single-day sell-off, followed by a 9% or greater single-day rally. Well, going back to 1950, we can see in the following image that Friday, March 13, 2020, marked that one lonely occurrence, as shown by the blue dot.

 

Source for all charts and data: Optuma

None of us know what the future brings. And outlooks can change rapidly. The prior charts are just one of many reasons that have me remaining extremely cautious going forward. I will always err on the side of caution and expect the worst but hope for the best. Let's not get overly excited - or panicked, for that matter - about a single day's event. In this environment, things can turn on a dime. If you would like to further discuss, click here.

The indexes mentioned in this communication are unmanaged and not available for direct investment. Past performance is no guarantee of future results. Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information contained in this commentary has been obtained from sources that are reliable. This presentation is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.

 

 

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