A Closer Look at an Unusual S&P 500 Pullback

^GSPC ^VIX The S&P 500 Index (SPX) suffered its worst day of the year last Friday, falling more than 2.5%.The index was within striking distance of an all-time high and had gone more than four and a half months without a 2% daily loss. What s more, the Cboe Volatility Index (VIX) closed the day before at 15.40, hinting that option traders weren’t expecting a big move. This week, I’ll look at how the SPX has historically performed over the short and medium term following large one-day declines. Then I’ll see if results are different when you consider the additional factors I mentioned. The table below shows how the SPX has performed after any daily drop of 2% or more going back to 2010. I looked at time frames from one week to six months after, and the average return after these pullbacks beat typical market returns for each period. The percentage of positive returns matched the typical results in the shorter term and was slightly higher in the longer term. The outperformance was mainly due to bigger rebounds. Gains and losses were both bigger after 2% down days but the increase in average gain was bigger than the increase in the average loss. The market goes through periods of high volatility and low volatility. So, big daily returns, in either direction, tend to happen in bunches. The recent drop wasn’t like this. It was the first big decline since January. The table below shows how the SPX performed after a 2% drop, which was the first such decline in at least two months. As expected, the sample size is a lot smaller, but the results are notably different. The returns significantly underperformed after all other 2% declines across every timeframe analyzed. When you compare this table to typical market returns (the anytime returns since 2010), the returns were weakest in the first month. The longer-term returns over the next three and six months were in line with typical anytime returns but failed to outperform like we saw after 2% down days in general. I mentioned earlier how the SPX was near an all-time high before Friday’s 2% fall. The table below shows the returns after the SPX closed within 2% of a high the day before the big decline. There were 19 occurrences and again, the performance wasn’t nearly as good compared to the return after any decline. Similar to the table above, the underperformance is primarily in the short term with longer term returns similar to typical market returns. Another factor indicating the drop surprised markets was the low reading on the VIX. The day before the SPX dropped over 2%, the VIX closed at 15.40. For reference, the average VIX level since 2010 is about 18.50. The table below shows SPX performance after 2% drops with the VIX closing below 17 the day before the drop. There have been 20 previous data points. The data shows an underperforming average return for all timeframes except for one month. For whatever reason (probably randomness), the index seemed to rally some from two weeks to one month, but then slowing down from there. Finally, I found the historical instances that met all three criteria laid out above. There were 11 times since 2010 the SPX declined 2% or more in a day for the first time in at least 60 days, and the index was within 2% of an all-time high the day before, and the VIX closed below 17 the day before. I list each of the dates below. The only 2% drop this year before the recent one was in January, and that day also met all three criteria. The results are very mixed across the timeframes considered. The summary table shows outperformance vs. typical returns for the one-week returns. Then it has a low average two-week return (other metrics, however, look better). The returns at a month beat typical market returns. I’m skeptical that a one day return can have much affect on the three and six-month returns but looking at the numbers, these signals show underperformance at three months but then the six-month performance is better than anytime index returns but not as good as the returns after all 2% pullbacks. Since 2010, 2% daily pullbacks have, overall, been good buying opportunities. However, when you consider the factors covered above (first 2% decline in 60 days, near an all-time high, sub-17 VIX), the returns are less bullish. In short, not all 2% down days the same, and this one looks less attractive than the average 2% daily drop.

A Closer Look at an Unusual S&P 500 Pullback

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