What 2020’s Equity Vol Says About 2021

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What 2020’s Equity Vol Says About 2021

Published 11/2/20

The S&P 500 has moved more than 1 percent up or down on almost half (47 pct) of trading days thus far in 2020. That’s our fundamental benchmark of how much investors “feel” volatility, as 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 reference, there is typically one 1 pct day/week in normal times. Here is an update for 2020’s count on a quarterly and annual basis:

  • 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 QTD: 10 one percent days, including today (Monday), versus the Q4 average of 14.
  • 2020 YTD: 99 one percent days, far surpassing the whole-year average of 53 over the last 6 decades.

Bottom line: the S&P will see at least 100 “plus-one percent days” this year, a threshold it has only hit during 6 other years over the past +6 decades or just 10 percent of the time. Therefore, we looked at what happens the next year in terms of returns and volatility after this rare occurrence of elevated equity market churn. There’s three scenarios, two positive outcomes and one negative in the following year:

Scenario #1: 2008 Financial Crisis (Good):

  • 2008: -36.6 pct total return for the S&P, 134 one percent days
  • 2009: +25.9 pct total return, 118 one percent days
  • 2010: +14.8% pct total return, 76 one percent days

Takeaway: the quarterly record for +/-1 percent days was 50 in Q4 2008, adding to that year’s annual all-time high of 134 one percent days. That was due to a delayed fiscal policy response to the Financial Crisis after the national election that November. The change in political power stopped progress on passing a stimulus package, and Congress did not pass ARRA – the landmark recovery bill for the Financial Crisis – until a few months later in February 2009. The market finally bottomed one month after in March 2009.

Scenario #2: 1973/1974 Oil Crisis (Good):

  • 1974: -25.9 pct total return for the S&P, 115 one percent days
  • 1975: +37.0 pct total return, 80 one percent days

Takeaway: both 1973 (S&P down 14.3 pct with 78 one percent days) and 1974 were two painful years for US equity markets due to the Saudi Oil Embargo and resultant oil crisis. Nevertheless, a year after the S&P passed the +100 one percent day threshold in 1974, volatility abated and the index rallied +37 pct in 1975.

Scenario #3: 2000-2003 Dot Com Bubble Burst, 9/11 and Gulf War II (Bad):

  • 2000: -9.0 pct total return for the S&P, 103 one percent days
  • 2001: -11.9 pct total return, 107 one percent days
  • 2002: -22.0 pct total return, 126 one percent days
  • 2003: +28.4 pct total return, 83 one percent days

Takeaway: the S&P registered +100 one percent days and deep negative returns for three straight years in the early 2000s due to a series of shocks that were both economic (Dot Com Bubble Burst) and geopolitical (domestic terror attack and international oil shock).

Overall, the S&P 500 is up 2.5 pct year-to-date on a price return basis, unusually tame for years with +100 one percent days that typically see more dramatic double digit returns in either direction. Even still, we think this year’s recession best resembles the first scenario in 2008/2009 given that we are mostly dealing with an economic shock and have a similar election setup. Investors want more fiscal stimulus ASAP, but a Democratic sweep of the White House and Congress this week could delay a new deal until after Inauguration Day 2021. US equities should rally thereafter as long as investors think the policy response is adequate, but volatility will remain elevated and US equities will likely suffer until that happens.