There have been 10 days where the S&P 500 has risen or fallen by greater than 1% in a given trading session in Q1 2020. That’s how we gauge volatility because it is a large enough swing that it starts to change how investors allocate capital, as we have seen with the recent outbreak of COVID-19. A few points here:
- Last year, there were a total of 38 one percent days compared to the annual average of 53 over the last 6 decades. That means after just the first two months of the year, the S&P has already had over a quarter (26%) of last year’s total one percent daily moves and is also almost a fifth (19%) of the way to the annual average.
- The Q1 average for one percent days is 13 back to 1958 (first full year of data). Given that there have already been 10, there will likely be an above average number of +1% days this quarter. Under normal market churn, there should be one +1% daily move a week, so volatility has started the year above pace.
- Today is a good reminder that +1% days tend to cluster together, whether it be to the upside or downside. Just because the S&P snapped back by +4% today does not mean the market is in the clear, in other words.
Given that the broader stock market has been more volatile than usual this year, we looked at quarters in the past that have been especially choppy. Here’s what we found:
- Since the start of 1958 (first full year of data), the average quarterly number of +1% daily moves in the S&P is 13.3 with a standard deviation of 9.7.
- That makes 32.6 one percent days the number to watch as it is two standard deviations away from the average and therefore truly uncommon.
There have only been ten quarters that have had 33 or more +1% days, or two standard deviations away from the average. Given that +1% days occur most during market downturns, here are those periods and when the market bottomed during those times:
- Q3 1974 (oil shock): There were 38 one percent days during Q3 1974, but the S&P bottomed just a few days after this quarter ended.
In terms of volatility, there was an above average number of +1% days in the 3 quarters leading up to Q3 1974 and an above average number of one percent days in the 6 quarters after.
- Q4 1987 (Stock market crash of ‘87): 42 one percent days and the S&P bottomed in the same quarter in early December.
There was an above average number of 1% days in the 3 quarters leading up to Q4 1987 and the three quarters after.
- Q3/Q4 2002 (Dot com bubble/lead up to Gulf War II): There were 44 and 34 one percent or greater daily moves in Q3 and Q4 of 2002 respectively. The S&P bottomed in the beginning of Q4 2002.
There was an above average number of one percent days in the 17 quarters leading up to the especially high numbers in Q3/Q4, and 3 quarters after.
- Q3/Q4 2008 and Q1/Q2 2009 (Financial crisis): There were 36 and 50 +1% days in Q3 and Q4 of 2008 respectively, and 41 and 34 +1% daily moves in Q1 and Q2 of 2009 respectively. The S&P bottomed in Q1 2009.
There was an above average number of +1% days in the 4 quarters leading up to Q3/Q4 2008 and five quarters after Q1/Q2 2009.
- Q3/Q4 2011 (Greek debt crisis): 33 and 36 greater than one percent daily moves in Q3 and Q4 2011 respectively. The S&P troughed at the beginning of Q4 2011.
There was an above average number of 1% days in the quarter before Q3 2011, but the quarter after Q4 2011 had below average volatility.
Here’s what we take away from this data:
#1: At ten +1% daily moves in the S&P 500 thus far in Q1, this quarter has a long way to go before getting to one standard deviation away from the average (23), let alone two (33). It is even still technically below the Q1 quarterly average of 13, so we’ll have to see what happens in this last month of the quarter.
#2: That said, quarters that had registered daily moves of +1% that was 2 standard deviations away from the average don’t tend to just happen out of the blue. There’s typically a buildup of an above average number of +1% daily moves in the quarters leading up to such an unusually volatile quarter, and it also typically takes a few quarters for above average volatility to abate back to normal levels thereafter.
#3: History says it usually takes at least a few quarters with above average volatility to get to one in which the number of +1% daily moves is two standard deviations away from the average, signaling enough market distress to call a bottom. That means this above average volatility environment could last with us for several months. The good news is if the economic impact of COVID-19 is bad enough to get us to an especially volatile quarter (+33 greater than 1% days), the market has usually bottomed during these kinds of quarters in past market downturns. Of course the Financial Crisis was a more extreme case hitting above this level 4 quarters in a row between the back half of 2008 and first half of 2009, but even during that case it bottomed during the third month of that streak (Q1 2009).
Bottom line: don’t be fooled by today’s rebound in the S&P. Volatility happens to the downside and upside as both usually cluster together.Given the uncertainty about when the coronavirus will be contained and its economic fallout on global economic growth, we expect above average volatility to persist. As for calling a bottom, look for when there’s over 33 one percent days in a given quarter as that’s the level that typically gives a reliable buy signal.