Outsized Vol, Finding a Low

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Outsized Vol, Finding a Low

This year has been exceptionally volatile for US equities, with the S&P 500 down over 3 percent on 8 days. That’s over 3 standard deviations (1 percentage point apiece) away from the long run mean for daily returns (+0.03 pct). To show just how unusual this is, consider these stats:

  • The S&P has only fallen by +3 pct on 124 out of +16,300 days (0.8 pct) since the start of 1958 (first full year of data).

  • In the last 65 years including 2022, fewer than half (29 years, 45 pct) have had at least one down +3 pct day. Over half (59 pct) of these 29 years only saw one or two down +3 pct days.

The upshot here is that any daily decline of 3 pct or more for the S&P 500 is very rare. Here are the 10 years with the highest number of +3 pct down days versus this year over the last +6 decades:

  • 2008: 23
  • 2020: 16
  • 2009: 12

  • 2022 YTD: 8

  • 2002: 7
  • 1987: 6
  • 2011: 6
  • 1998: 5
  • 2010: 5
  • 2018: 5
  • 2000: 4

Takeaway: there’s still an entire quarter left to go in 2022, and this year already ranks 4th in terms of the S&P producing the greatest number of down +3 pct days. That’s only behind the Financial Crisis and Great Recession in 2008 – 2009 and the Pandemic Crisis in 2020, and ahead of years with major wars and other economic/geopolitical crises.

So, what does this data mean for the S&P 500 going forward? Volatility and returns are inversely correlated, so let’s drill down on the years that have had more down +3 pct days than this year to see how US equities fared during such high levels of choppiness.

  • 2008 and 2009 (23 and 12 +3 pct days, respectively): most of these down +3 pct days were clustered in the last 4 months of 2008 due to the Financial Crisis and Q1 2009 due to a lack of fiscal policy response. The US economy/equity markets had to wait until February 2009 for the American Recovery and Reinvestment Act of 2009 (ARRA) to pass due to the presidential and congressional election cycle. Stocks finally bottomed in March 2009, one month after ARRA passed.
  • 2020 (16): most of these down +3 pct days were concentrated between February and April 2020; half (8) were in March. It took a series of fiscal stimulus packages and monetary policy support starting in March 2020 for volatility to come down, and stocks bottomed on the 23rd of that month.

Bottom line: history shows that reducing outsized volatility of the sort we have been seeing this year takes a shift in policy from the US government and/or the Federal Reserve. Markets have been trying to predict a turning point for Fed policy for months now, with as-yet little success given the ongoing strength in US labor markets and still-high inflation. Years like 2008 show current elevated market volatility can bleed into 2023 unless wage/price inflation trends signal a possible change in policy. That makes Q4 2022 a critical time for stock prices. The longer volatility continues, the more likely it will substantially affect valuations and limit longer-run returns.