On March 9, 2020 the S&P 500 fell over 7%. This triggered circuit breakers and was the biggest one-day decline in over a decade. What do prior large drops suggest may be next for investors?
It is notable that other examples of big market drops exceeding 7% for the S&P 500 in recent history came in 2008 and 1987. Both of those years saw more than one such big daily decline. 2008 actually saw four big market declines all of 7% in the fall of that year. 1987 is remembered for the 20% one-day market drop, Black Monday. Nonetheless it is often forgotten that the following Monday the market fell another 8%. This is perhaps not surprising, periods of volatility do tend to cluster. Mathematical models suggest such extreme moves in the market should be extremely rare and isolated. In practice, they often aren’t. We may be in for more ups and downs. In fact, that’s exactly what the VIX index, which measures implied volatility, is telling us is on the cards. Just as today’s price drop is suggestive of aspects of 2008, so is the elevated VIX.
Still despite further declines and elevated volatility both these historical periods of 1987 and 2008 also came close to clear buying opportunities for stocks. There are often rebounds and again further big decline days in the markets. However, in neither case of 2008 or 1987 was the bottom immediate after the big drop. In 1987 almost 2 months were needed to then reach the absolute low. In 2008 the low was loosely another 4-6 months behind the biggest daily falls. Still both periods were ultimately desirable buying opportunities for the patient investor, in retrospect. Nonetheless in each case buying at the time of the extreme drop, ultimately proved a little premature.
As always, we should exercise caution with this data. Daily declines exceeding 7% are rare. In recent history we have a handful of examples. Reading too much into these may be misleading since the data is scant. Still we may see a short-term bounce followed by elevated volatility meaning perhaps another big drop or two. We also likely aren’t at the bottom yet, that may be a few months off if history is any guide. This is similar to the signal researchers found from an elevated VIX, volatility may be high in the coming months, and there may still be some nasty surprises in store but the overall trend could soon become bullish. The counter-point to this is that the U.S. market still remains at high relative and absolute valuation levels even after the decline. That may be a reason to look to less richly valued international markets as a way to play any potential recovery in stocks. But remember, the volatility we’re witnessing may take some time to recede.
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