What Q2’s Equity Vol Says About 2H 2020

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What Q2’s Equity Vol Says About 2H 2020

The S&P 500 could register a record number of days in 2020 when the S&P 500 moves by +1% up or down. That’s our fundamental benchmark of how much investors “feel” volatility, as any one-day move greater than 1% up or down is more than 1 standard deviation from the S&P’s mean daily return. There is typically one 1% day a week in normal times, but here’s an update on an especially choppy 2020 YTD:

  • 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.
  • 1H 2020: 68 one percent days, surpassing the whole-year average of 53 over the last 6 decades in just half a year. At this pace, the S&P could post 136 one percent days this year, exceeding the prior record of 134 in 2008 over the last 6 decades.
  • Q3 2020: 6 one percent days so far in July, about halfway to the Q3 average of 13 with two months left in the quarter.

Bottom line: 30 or more one percent days in any given quarter is very unusual and only happens 7% of the time. The S&P hit that threshold in both Q1 and Q2 of this year. That said, the S&P 500 bottomed on March 23rd and is now up 45% since. We think the quarterly peak for one percent days will therefore be 38 in Q2 as it would take a drastic situation to retest the March 23rd low in the S&P. The cadence of one percent days so far in the current quarter reflects that reality. With 6 one percent days in the first month of Q3, it is on pace to hit 18 such days; above average, but lower than both Q1 and Q2.

With that in mind, here are our 3 investment takeaways from this data:

#1: The quarterly record for +/-1% days was 50 in Q4 2008, largely due to a delayed fiscal policy response to the Financial Crisis after the national election that November. Markets knew the change in political power would suspend progress on implementing a stimulus package, which is what transpired. Congress did not pass ARRA – the landmark recovery bill for the Financial Crisis – until a few months later in February 2009 (one month before the market bottomed). Consequently, 2008 had the most number of +/-1% days (134) in any year on record, concentrated in Q4. Once the new political regime took place and action, however, market volatility declined thereafter: 41 one percent days in Q1 2009, 34 in Q2 and 21 and 22 in Q3 and Q4 respectively.

#2: Thus far, the policy responses from both the Federal Reserve and Federal government have been fast and aggressive, which is why the S&P 500 did not register as many one percent days as during 2008. Even still, the 2008-2009 experience shows the importance of the Federal government passing even more stimulus as soon as possible.

One wrinkle also not yet discussed: should President Trump and Republicans lose the White House and Senate this November, it could create the same kind of power vacuum as occurred in Q4 2008. In that scenario, volatility would ramp higher and the S&P 500 could post a record annual number of 1% days this year, even greater than during 2008. Depending on how the virus and economy take shape this fall, it’s important to capital markets that 2020 does not end up being a delayed version of 2008 by putting a halt to however DC needs to respond from November 4th to Inauguration Day 2021.

#3: Given that Q2 should represent a peak for 1% days (38) amid the COVID-19 Crisis, we looked at what happens in the next two quarters after a quarter posts 35+ one percent days (very unusual) relative to prior market cycles. Here’s a quick breakdown:

  • These quarters include: Q3 1974 (38 one percent days), Q4 1987 (42), Q3 2002 (44), Q3 and Q4 2008 (36 and 50), Q1 2009 (41) and Q4 2011 (36).
  • The average S&P 500 next-quarter price return after these periods with +35 one percent days was +1.9% with 31 one percent-plus days. Excluding 2008 and 2009, the return was +8.2% with 24 one percent-plus days.
  • As for the second quarter average after those with +35 one percent days, the return was +5.6% with 28 one percent days. Excluding 2008 and 2009, the return was +5.1% with 25 one percent days.
  • Zooming in on 2008 and 2009 since it skews the data, here were the results after hitting a quarterly string of 35+ one percent days in Q3/Q4 2008 and Q1 2009:

    Q4 2008, Q1 2009, Q2 2009 and Q3 2009 returns: -22.6%, -11.7%, +15.2%, +15.0%
    Q4 2008, Q1 2009, Q2 2009 and Q3 2009 one percent days: 50, 41, 34, 21

Bottom line: equity volatility and returns are typically inversely correlated, so if last quarter is the high for one percent-plus days, history says volatility should abate (which it has so far in Q3) and the S&P should have a positive return in Q3 and Q4. The one caveat: the government and markets know more fiscal stimulus is needed.

Final overall point: the S&P 500 has been historically close to a bottom around the time that it registers 35+ one percent days in a given quarter. We think that happened at the end of Q1 for the current crisis and that Q2 will therefore mark peak volatility. The S&P is performing how history suggests so far in the quarter (Q3) following one that had 35+ one percent days (Q2): less volatility (just 6 one percent days thus far) and a positive return (+4.7% in July). This bodes well for the balance of the year, as long the Federal government keeps responding adequately to the economic challenges that arise.