When To Buy The Dip

We’ve been warning for several weeks that August would be an especially volatile month after a quiet year through July. Our “Strong January Playbook” and volatility work showed that clearly. With volatility now in full force and likely to continue, it’s time to look for an investable bottom. We outlined four indicators to watch in prior reports this week on that front, and today we’ll share a historically reliable signal so you’re ready to jump in at the right time.

Here is a breakdown of the data:

• 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 60 years. Why down 4%? It is unusual enough to derive a signal. A negative 3% or greater day is more common at 100 times over the same period, for example.
  
  
• During the 41 times the S&P has fallen +4%, the average one-day drop was negative 6%. Excluding the outlier on Black Monday 1987 (-20.5%), the index has been down an average of 5.6% on these days.
  
  
• The day after such a drop the S&P on average rebounded, up 1.1%. Again, we calculated the average if you exclude the outlier on Black Monday because the session before the market was down 5.2% and also triggered our 4% rule. In this case, the S&P was up 1.7% the next day.
  
  
• Over the next month after a +4% daily drop the S&P was relatively flat (up an average of 45 basis points), but over the next year the index was up an average of 20%. Breaking down the latter figure, the S&P was up 78% of the time over the next year, including up by double digits +70% 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 on February 5th 2018. The S&P rebounded the next day, up 1.7%, and the next month, up 2.7%. The index was only up 3.4% over the next year given the major selloff in Q4 2018, but still a gain. If you had bought the close on February 5th of last year and held through today’s close, you’d be up 8.9%.

Bottom line: many investors look for violent one-day declines for attractive buying opportunities, but it takes a truly uncommon event like a down 4% day to best signal an investable bottom. The VIX has peaked the most in August and October, so the next three months is the most likely time it could happen, especially with trade and Fed related headline risks. If you can hold on through incremental volatility, history has shown the S&P usually recovers by double digits after a year. This is a rare but important opportunity, so be on the lookout.