The Brief History Of 7% Losses

Summary

[i]This article looks at the rare history of single day 7% losses for the S&P 500 and its predecessor indices.

Good news - stocks have tended to bounce back strongly the next day.

Bad news - years that have featured a daily return of -7% return have tended to be quite bad for investors.[/i]

The extreme moves in the S&P 500 (SPY) of late have given us the opportunity to study some market history. Monday’s -7.6% return for the S&P 500 was the worst single day since December 1st, 2008. Since the 1930s, only single day sell-off’s during infamous routs in 2008 and 1987 were worse than Monday’s drop.

Monday was the 19th worst day on record, and one of only 22 rare days where markets have fallen more than 7%. There is a silver lining. On days where markets have fallen as much, the next day tends to offer a short-term bounce. On average, the previous 21 days following a 7% down day returned an arithmetic average of 2.88%, far above the average daily price return of 0.03%. In the 21 previous episodes, 16 saw gains. The volatility on those subsequent days was very high though, roughly 5x the average volatility of the index over time.

While the next trading days after -7% returns tend to be strong, the years in which these sharply negative daily returns happen are quite negative. The table below has full year returns for years that featured a -7% daily return.

Only 1987, which featured a strong start before the fall collapse, and 1933, which marked the end of the Great Depression, posted positive full year returns. The market circumstances we are dealing with in the current environment are rather historic. Years that have featured this type of volatility and negative daily returns have tended to not be great for stocks overall.


Yearly return after 7% daily drop.png

If you change the drop to less than or equal to 5 % then the average mean return is positive a year later. Selection bias at its finest:)


sp500_After_minus_five_percent_day.PNG

Scott,

The reason 7% is chosen is probably due to the circuit breaker rules that is being triggered on Mon.

Regards
James

But the circuit breaker rule is 5%, is it not?

Nisser,

The circuit breaker rule is at 7% (15 minutes pause) then 13% (15 minutes pause) and then 20% (close for the day).

The 5% circuit breaker only applies the overnight CME futures (after hours/ pre market)

Regards
James