With equity volatility ramping higher again, today we have an update on our “one percent” days analysis and what it says about market choppiness going forward. We keep track of the number of trading sessions when the S&P 500 moves more than 1 percent up or down from close to close (like today) because it’s our benchmark for how much investors “feel” volatility. Any one-day move greater than 1 pct to the upside or downside is +1 standard deviation from the S&P’s mean daily return back to 1958.
For example, while there is typically one +/-1 percent day/week in normal times, the S&P rose or fell by 1 pct or more on 110 trading days in 2020. That was the fifth most volatile year in the past 6 decades, with the S&P moving +/-1 pct on almost half (43 pct) of trading days last year. Here is a recap of 2020’s quarterly and annual count:
- Q1 2020: 30 one percent days versus the Q1 average of 13 since 1958 (first full year of data).
- Q2 2020: 38 one percent days compared to the Q2 average of 13.
- Q3 2020: 21 one percent days versus the Q3 average of 13.
- Q4 2020: 21 one percent days versus the Q4 average of 14.
- 2020 overall: 110 one percent days, more than double the whole-year average of 54 over the last 6 decades.
The upshot: 2020 was a particularly wild year, with all four quarters experiencing above average volatility. By comparison, Q4 2019 had just 6 one percent days and the entire year had only 38, both well below average. As for this year, there’s already been 6 one percent days so far in Q1, including today. This works out to 1.5 such days per trading week, higher than the historical average.
So, how long does it typically take markets return to normal after such volatile times? We looked back to the number of one percent days on a quarterly basis during 3 previous choppy periods. Here’s what happened and their historical contexts:
#1) 1973: The 1973 oil crisis commenced in October of this year, with OPEC imposing an embargo on western countries which backed Israel during the Yom Kippur War. The number of one percent days went from average (12) in Q3 1973 to 27 (double the average) in Q4 1973. There was an above average number of one percent days for 9 more quarters thereafter. In other words, volatility did not settle down for over two years after the initial shock.
#2) 2000: There was an above average number of one percent days during all quarters of 2000 through Q3 2003, and volatility did not return to normal until Q4 2003. This was due to a series of shocks (rather than just one, as in 1973) from the dot com bubble bursting to the 9/11 terror attacks and finally the Iraq War.
#3) 2008: The all-time quarterly record for one percent days was 50 in Q4 2008 during the Financial Crisis. The number of one percent days remained above average for the next 7 quarters until US equities eventually calmed down in Q4 2010.
Takeaway: we think the current crisis more closely resembles the periods of volatility that started in 1973 and 2008 rather than the post-2000 experience, when volatility remained unusually high for many years due to multiple economic and geopolitical shocks. Given that it takes about two years for volatility to fall back to average levels and the number of one percent days peaked in Q2 2020, volatility should continue to drop barring any other shocks but may not return to normal until mid-2022. Of course, this will also depend on vaccine rollouts and their ability to fight new mutations of the virus.
Bottom line: elevated levels of volatility after a single shock take, on average, about 2 years to unwind as the economic environment remains uncertain and markets re-evaluate how to first predict and then price corporate earnings. The silver lining: volatility and equity returns are inversely correlated, so US equities should rally over time as volatility continues its downward trend from the 2020 peak.