Does it matter if volatility picks up when stocks were near fresh highs?
Whether it’s going up or down, stocks have been making bigger daily moves recently. The chart below shows the S&P 500 Index (SPX) along with its average daily absolute return over the past month of trading. That’s the daily percent change of the index whether it moves up or down. Investors tend to get uneasy when they start seeing big daily swings in their portfolio values. I’m going to look at the historical record and find out what this data has meant for stocks going forward.
Going back to 1950, the first table below takes a general look at how the S&P 500 has performed when the average daily change surpasses 1% for the first time in at least three months. Looking at the overall performance, there has been some initial underperformance, but the longer the time frame, the better the returns look. For example, after the 33 signals since 1950, one month later the index has averaged a gain barely above breakeven, with just under half of the returns positive.
Typically, the S&P 500 averages a gain of 0.71% with over 60% of the returns positive. Three months after a signal, however, the S&P has outperformed its usual return, averaging a gain of 3.76% vs. 2.14%. After a signal the index has been up nearly 80% of the time after three months when the typical percent positive is at 66%.
The spike in daily volatility looks like it lasts for a bit after a signal, but like the performance, it’s closer to normal the longer the time frame goes. The standard deviation of the two-week returns after a signal was around 4.8%, significantly higher than 2.94%, which has been the typical standard deviation. Also after a signal, the S&P 500 moved up or down more than 3% on average when usually it moves up or down closer to 2% over two weeks. When you get to three and six months after a signal, the standard deviation of returns looks closer to normal.
Volatility spikes typically occur during sharp pullbacks. There was a pullback in early August, but it wasn’t especially severe. In fact, when the signal occurred, the S&P 500 was within 4% of its all-time high. I was wondering if the summarized returns looked any different for signals that occurred near an all-time high. I found that 12 of the prior occurrences happened within 10% of the index's all-time high. The table below summarizes those results.
The results below are encouraging in that they’re more bullish than the returns for all signals. The average return is better than the anytime returns at every time frame; even the short-term time frames where they underperformed in the table above. In these specific instances, the average return is higher than normal returns and they were positive over 90% of the time.
Also different is the volatility of stocks going forward. When the daily average change hits 1% when stocks are near an all-time high, the index has tended to calm; showing less volatility than normal times as measured by the standard deviation of returns.
