How quickly things can change.
When Friday’s equity market sell-off morphed into Monday’s tailspin, the CBOE Volatility Index (VIX) shot as high as 35.73—a 165% increase in two days that (almost, not quite) made the S&P 500’s (SPX) 7% drop over the same period look like chicken scratch.
Then the VIX jumped above 45 in yesterday’s session—its highest reading since August 24, 2015, and the second-highest since October 2011—as the SPX extended its decline from the January 26 high to 9.7%.
While many headlines that focused on irrelevant factoids—e.g., “Dow’s biggest one-day drop ever!”—may have made good reading, they didn’t do much to shed light on what was happening. Yes, Monday’s 1,175-point loss was the Dow’s largest point loss in a day, but on a percentage basis (-4.6%), it checks in as only the 93rd worst among all one-day losses since January 1928.
That’s not to downplay the sting of such a move—and what it may mean—but at times like this, it’s a good idea to check in on what the market has done in similar situations.
Since what occurred is a sharp pullback from a high, let’s look at all the times the SPX has declined, say, 6-10% over a seven- to nine-day period after making a high that was above the highest high of at least the previous two weeks. It’s not the only way to define what happened between January 26 and February 5, but it captures the essentials.
There have been 90 SPX sell-offs like this since 1960. Here’s what’s happened after them:
●The SPX tended to bounce back over the next few days, with the index trading higher 65% of the time after three days, and posting an average gain of 0.64%.
●After that, the SPX’s gains diminished; after nine days the index was, on average, back where it started.
The overall impression of this composite picture of these steep sell-offs is that the market, more often than not, rebounds temporarily, but then drifts sideways to lower over the next several days.
One additional piece of information (one that was still up in the air midday yesterday) is how the market closes on the final day of the pattern. If we look only at those sell-offs that closed in the upper half of the day’s range (implying at least some intraday bullishness), we are left with 37 examples and the following performance characteristics:
●The SPX again bounced back over the next few days, with the index higher 74% of the time after three days, and posting an average gain of 1.42%.
●After that, the SPX’s gains again shrank, similar to the way they had in the previous example.
When the SPX closed in the bottom half of the day’s range, the price action over the next several days was more volatile and bearish.
It’s impossible to know how well the current scenario will track these tendencies—or if it will at all. It’s interesting, though, that the bounce-and-retreat scenario outlined here could imply a test in the not-too-distant future of Monday’s low. If and when that occurs, the VIX will bear watching more closely than ever.
VIX spikes that accompany sharp market sell-offs like the current one are sometimes followed by slightly less extreme VIX spikes a few days to a few weeks later, and these often occur when the SPX is making a lower low—in other words, the market is pushing below the level of the initial market sell-off while the VIX is registering less “fear,” which can imply an up move is possible. One small-scale but recent example is the set of VIX spike highs (and SPX lows) from August 11 and August 18, 2017.
Just as no one could have pinpointed January 26 as the SPX’s highest high (for the time being), no one is going to be able to perfectly time the end of the current retracement. If the market defines Tuesday’s low as an important support level by bouncing off of it, keep an eye on the VIX if and when the SPX returns to it.