Correction reflections

Monday was a conspicuous day for the stock market, to say the least. The S&P 500 (SPX) opened nearly 3.7% lower, a move it has exceeded only three other times since 1982—all of them occurring during the March 2020 COVID sell-off. The Cboe Volatility Index (VIX) jumped as much as 181% intraday, something it had never done before.

Then there was the Nasdaq 100 (NDX) tech index, which opened 5.4% lower on Monday after closing in correction territory on Friday:

The picture changed throughout the day. At one point the NDX trimmed its loss to around -1.5%, then ended the session down 3.3%—a sizable decline, yes, but 2.6% above the day’s low, and in the upper half of its range.

That seemingly modest bullish momentum spilled over into Tuesday, with the NDX up more than 2% around 2 p.m. ET. While at that point many bulls were probably breathing much easier than they had been 24 hours earlier, longtime traders may have had a more cautious take on the bounce.

In addition to the NDX’s historical pattern of declining more after it initially falls into a correction (see “Tech corrects”), there’s also the broader tendency for the market to eventually test a high-volatility low like Monday’s, even if it doesn’t trade below it by much, or for very long. In other words, high-volatility events, like earthquakes, sometimes have aftershocks.

As Morgan Stanley & Co. strategists pointed out on Monday, lost in all the discussions of recession risks and Fed policy was the reality that stock valuations had gotten very “rich” this year. They also noted the recent sell-off didn’t necessarily make them exceptionally attractive, at least in terms of the S&P 500.¹ As a result, they expect markets to be “vulnerable in the near term,” an outlook that jibes with the tendencies outlined in “Tech corrects.”

Finally, the NDX’s modestly bullish close on Monday—up notably from the day’s low, and in the upper half of its range—may have been sending a counterintuitive signal. The following chart shows the NDX’s median returns five and 10 trading days after the 62 other times the index fell at least 5% intraday and closed lower:²

The index actually performed better when the NDX closed in the lower half of the sell-off day’s range (green columns), rather than the upper half (blue columns), as it did on Monday. The NDX’s five-day median return was positive in both cases, but it was much larger after the weaker-closing sell-off days. At the 10-day mark, the NDX had a negative median return after the stronger-closing sell-off days, while the return after the weaker-closing days was still positive.

One possible explanation is that weaker-closing days represent situations where the market has gotten more of the selling “out of its system,” while the stronger-closing days are situations where volatility may not have entirely run its course.

Today’s numbers include (all times ET): mortgage applications (7 a.m.), EIA Petroleum Status Report (10:30 a.m.), Consumer Credit (3 p.m.).

Today’ earnings include: Disney (DIS), Global Payments (GPN), Lyft (LYFT), Novo-Nordisk (NVO), Ralph Lauren Corp (RL), Rockwell Automation (ROK), Shopify (SHOP), AppLovin (APP), Duolingo (DUOL), Root (ROOT), Wynn Resorts (WYNN).

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¹ MorganStanley.com. Making Sense of the Correction. 8/5/24.
² All figures reflect Nasdaq 100 (NDX) daily prices, 1985–2024. The NDX closed in the upper half of the sell-off day’s range 17 times (not counting Monday) and closed in the lower half 45 times. The 62 days fulfilling the pattern criteria in the article also had to follow a down day. Supporting document available upon request.