Buy The Very Big Dip, Not the Drip

Published April 25th, 2018 by DataTrek Research:

It may be harder to make money in US stocks compared to the last few years of low volatility and high returns, but there are still some benefits to a twitchier market. Even though we’re less than 90 trading days through 2018, US stocks certainly qualify for that descriptor. There have already been 30 times in which the S&P 500 has generated daily returns of +1% to the upside or downside this year. That compares to just 8 for all of last year. Without even being half way through the year, the market is already over the half way mark towards the average of 53 daily moves each year since 1958.

So what’s the silver lining? More instances of violent one-day declines can mean more attractive buying opportunities for brave investors. But does it pay to catch the falling knife? We pulled the data and here’s what we found:

• We looked for daily returns of negative 4% or greater for the S&P 500 dating back to 1958 (the first full year of data). This has happened just 41 times in 59 years, but already this year there have been 7 days where the S&P was down between 2.1-4.1%.

• During the 41 times the S&P has fallen +4%, the average one day drop was negative 6%. Excluding the outlier on Black Friday 1987 (-20.5%), they were down 5.6%.

• The day after such a drop the S&P on average rebounded, up 1.1%.Again, if you exclude the outlier on Black Friday (as the session before the market was down 5.2%), the S&P was up 1.7%.

• Over the next month, the S&P was relatively flat (up an average of 45 basis points), but over the next year they were up an average of 20.1%.Breaking down the latter figure, the S&P was up 78% of the time over the next year, including up by double digits 75% of the time with a range of +12% to 67%.

• The last time the S&P was down over 4% in one day (4.1% to be exact) was in early February, but it rebounded the next day up 1.7% and the next month up 2.7%. It is down 36 basis points since then, but has plenty of time to catch up within the year.

Our takeaway: it may be worth buying the close of the next large daily dip of +4% in the S&P 500. If you can hold on through incremental volatility, history has shown it’s usually up by double digits after a year. We’ve not even gotten to the most volatile months of the year where the VIX has peaked the most since it was created in 1990: August and October. So there are potentially rare opportunities ahead, especially during a year that’s started off more volatile than usual, which we expect to continue.