LunaticTrader

Investing with the Moon

We got a 1% down day, what next?

Posted by Danny on March 22, 2017

The S&P 500 dropped 1.2% yesterday and this ends a 109 day streak without 1% drop. This is only the 13th such +100 day period since 1950 for the S&P, see my February post.
This drop was met with panicked reactions and crash warnings on social media, but people forget that 1% down days in the S&P 500 are nothing special. Over the last 67 years the S&P 500 has had 1662 such down days, or 10% of the time. That’s about one 1% down day every two weeks on average. But traders have very short memories and when something hasn’t happened for 5 months it feels as something special already.
The previous 1% down day was 11 October 2016, do you remember it? Probably not.

What’s more interesting is what happens after such a long streak ends. Here is the updated list of +90 day periods:

1pc_down2

While most investors intuitively think that a first big down day after a long absence of such days is a bearish sign and maybe the start of a crash, history shows us otherwise. More often than not the market just keeps climbing after that first big down day. Two weeks later (10 trading days) stocks were higher 8 times out of 13. After two months (40 days) the market was higher 11/13 for an average gain of 3% ( = 19% annualized). And a year later the S&P 500 was higher 11/13 for an average gain of 14.8%.
While this doesn’t guarantee similar gains in the coming months, there is certainly no reason to believe that yesterday’s 1% down day is a very bearish omen. If anything you should probably use this drop to pick up some cheap long term call options in the coming days. That’s the counterintuitive thing to do here.

Sure, this drop does some technical damage and has probably shocked a few investors. A trend line is clearly broken and now the market will search for a bottom from which it can start to rally again. How long that healing will take is a guess at this point. I like to keep an eye on my aggregate stats for bullish and bearish stocks in S&P 500. This is what we have at the moment:

spx

The number of S&P stocks in bullish mode (red line) has dropped to 230, which is below 50% for the first time since early November. Stats have been weakening slowly since early March, very similar to what happened in Jul-Aug 2016. When the red line bottoms out it will be a first positive development and when it gets back above the blue line we can start thinking about a new sustained rally.
I wouldn’t be surprised to see the market test the bottom orange trend line in the coming week or so. And that’s where it will get interesting.
Patience pays.

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