Panic. Relax. Repeat.
U.S. stocks have been exceedingly calm over the past year with the exception of a few sharp, short-lived declines. While the “buy-the-dip” mentality has been on display throughout the bull market, evidence suggests that investors’ reflexive buying is getting downright Pavlovian.
The latest example was last Wednesday’s abrupt 1.8% slide in the S&P 500, the biggest since September. Considering how placid markets had been, though, the more recent downdraft was a statistical rarity. Add in the speed of the rebound back to near record levels and last weeks’ price swings were highly anomalous.
“While not obvious on the surface, these markets are very weird,” William Chan, a derivatives analyst at Bank of America Merrill Lynch, wrote in a report Tuesday. “Perhaps even more remarkable than the capacity for U.S. equities to jump from calm to stress today is their ability to revert astoundingly quickly back to a state of calm.”
Investors have been bombarded with “buy-the-dip” calls persistently since the financial crisis. Key to this argument was that the Federal Reserve would continue to hold interest rates low and effectively force investors, who received paltry payouts from bonds, into buying stocks. It was known as the “Fed put,” a reference to the central bank as backstop against market declines. But the buy-the-dip behavior has only intensified since the Fed started to raise interest rates in December 2015.
Last week’s market drop was five standard deviations in magnitude compared with the S&P 500’s ultra-low level of realized volatility, something that’s happened only 18 times since 1928, according Mr. Chan. Put another way, such a steep drop during a placid market has occurred in fewer than 0.1% in trading sessions over 89 years.
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Standard deviation is a statistical measure of variation and in this context illustrates how deviant stock price swings were compared with prevailing conditions. That S&P 500 had gone for 15 consecutive trading days without moving up or down 0.5%, the longest such stretch since February 1969.
Mr. Chan notes that five standard-deviation stock declines are happening more often. There have been three such declines in U.S. stock market in less than a year, a frequency nearly 20 times higher than the long-term average. One struck following the “Brexit” vote last June and the other hit on Sept. 9.
Here’s the buy-the-dip aspect: Not only are stocks abruptly falling, they rebound with atypical haste. The S&P 500 recouped the bulk of its 5.3% two-day post-Brexit decline in five days; it took nine trading sessions after September’s 2.5% one-session drop. In only three days, S&P 500 recovered nearly all of last week’s 1.8% drop, the second-fastest rebound following a five standard-deviation drop on record, according to Mr. Chan.
“Market shocks have come to be viewed by investors as alpha opportunities rather than marking the onset of rising uncertainty,” Mr. Chan wrote. “Initially, a clearly visible and high strike Fed put taught the market to ’buy the dip’; now, however, this behavior has simply become a learned response function.”
May 23, 2017 at 10:08PM
from Chris Dieterich
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