What Q2’s Equity Vol Says About Q3 and Q4

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What Q2’s Equity Vol Says About Q3 and Q4

The S&P 500 has moved +1% up or down on over half (54%) of trading days so far this year. That’s our fundamental benchmark of how much investors “feel” volatility, as any one-day move greater than 1% to the upside or downside 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:

  • January through 6/30: 68 one percent days, already surpassing the annual average of 53 over the last 6 decades just half a year in.
  • 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.

Given that Q2 should represent a peak for 1% days amid the COVID-19 Crisis, what usually happens in the next two quarters relative to prior market cycles? Here’s the data based on other quarters that have registered +35 one percent days, a very unusual occurrence:

Q3 1974: 38 one percent days

  • Q4 1974 and Q1 1975 return: +7.9% and +21.6%
  • Q4 1974 and Q1 1975 one percent days: 32 and 25

Q4 1987: 42 one percent days

  • Q1 and Q2 1988 return: +4.8% and +5.6%
  • Q1 and Q2 1988 one percent days: 22 and 20

Q3 2002: 44 one percent days

  • Q4 2002 and Q1 2003 return: +7.9% and -3.60%
  • Q4 2002 and Q1 2003 one percent days: 34 and 31

Q3 and Q4 2008 and Q1 2009: 36, 50 and 41 one percent days respectively

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

Q4 2011: 36 one percent days

  • Q1 2012 and Q2 2012 return: +12.0% and -3.3%
  • Q1 2012 and Q2 2012 one percent days: 7 and 22

The upshot: 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.

Bottom line: markets snapped back in Q2 2020 and remain resilient because of aggressive fiscal and monetary policy actions, which is why we think Q2 will be the peak in one percent days for the COVID Crisis. Equity volatility and returns are typically inversely correlated, so if this quarter is the high for one percent-plus days, history says volatility should abate and the S&P should have a positive return over the next two quarters. That said, volatility will likely still be above average, so earning a positive return over the back half of this year will not resemble the smooth sailing one typically sees during mid-cycle bull markets.