Crash Bounces, Bond Rallies: What’s Next?

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Crash Bounces, Bond Rallies: What’s Next?

We’re in fat-tail times when it comes to US financial markets, seeing price moves in both equities and fixed income that should only happen once every few centuries if returns were normally distributed. Here are 2 examples and what they tell us:

#1: Yesterday’s 7.62% decline in the S&P 500 was a +7 standard deviation drop, and we got to wondering what the day after similar declines (+5 standard deviations) typically brings.

  • There have been 23 days since 1958 when the S&P has a +5% “crash”, including yesterday.
  • 3 of those days saw another +5% decline in the very next trading session (14% of the time). Those were November 19th 2008 (6.1% then -6.7%), November 5th 2008 (-5.3% then -5.0%) and October 16th 1987 (-5.2% then -20.5% on Black Monday).
  • The average rebound excluding those events (19 days, 86% of this data set) is 50.5%, meaning if the S&P 500 dropped by 6% on Day 1 it then rebounded 3% in the next trading session.
  • Looking at just the 2008 – 2009 Financial Crisis period of +5% declines (11 days) and excluding the 2 days that saw a follow-on “crash”, the rebound percentage ratio was 58%. A 6% decline on Day 1 brought a 3.5% bounce the next day.

The bottom line: today’s 4.9% rally was a 59% rebound from yesterday’s 7.6% decline, right on top of the average non-crash day from the Financial Crisis (58%) and modestly better than the long run average non-crash bounce (51%). While certainly a welcomed reprieve, in other words, it was not especially robust. At best, it does add something to our argument about nibbling at 5% down days which we outlined yesterday in our “Markets” section of our Full Report.

#2: The other notable outsized move of late is obviously long-term US Treasuries; we can use the TLT exchange traded fund (iShares +20 year Treasury) to assess how recent gains compare to historical norms back to Q4 2002:

  • The mean 30 calendar-day price return for TLT is 0.5% with a standard deviation of 4.5 percentage points.
  • The trailing 30-day price return at today’s close is 12.6%, putting it close to 3 (13.8%) standard deviations from the average return.
  • The best 30-day returns for TLT in the current market turmoil were through yesterday’s close at 20.6% and between 4 (18.3%) and 5 (22.8%) standard deviations.
  • As the chart below shows, we have only been in similar territory twice in the last 19 years. The first was Q4 2008 (peak of 29.4% for the 30 days ending December 29th) and Q3 2011 (+19.7% for the 30 days ending September 6th).

As for what such peak-y near term long-dated Treasury returns tell us about forward 1- and 3-month TLT returns, the historical record varies:

  • After the peak trailing return observation in 2008, TLT was down 13.8% a month later and 13.4% over the following 3 months.
  • After the 2011 rolling return peak, TLT was up 4.8% over the next month and 3.2% over the next 3 months.

The same holds true for S&P 500 returns after an outsized move in TLT:

  • The 1- and 3-month returns for the S&P 500 starting from December 29 2008 were -2.8% and -6.2%, respectively.
  • The 1- and 3- month returns for the S&P 500 starting from September 6th 2011 were flat (-0.02%) and +8.0%, respectively.

The bottom line: it’s been a great run for long-dated Treasuries, but unless you need a hedge for fresh equity exposure or believe there is another round of bad news coming it might be time to consider lightening up.