A 5% one-day drop in S&P 500 is ‘overdue,’ says strategist

Here’s some advice for investors waiting to buy the dip: keep waiting until you can buy the sinkhole.

That’s according to Nicholas Colas, chief market strategist at ConvergEx Group, who says that based on historical averages the market is overdue for a “crater,” when the Standard & Poor’s 500 Index falls more than 5 per cent in one day. There, investors will find the best buying opportunity, said Mr. Colas.

“These opportunities have arisen 22 times for the S&P thus far and occurred about every 2.5 years, or 4 years when excluding an abnormally choppy 2008,” Mr. Colas, a 25-year Wall Street veteran at ConvergEx, which provides brokerage and trading-related services for institutional investors, wrote in a note Monday. “Therefore we are overdue for another, which is not an unreasonable expectation given the heightened volatility this year. Make sure you are ready to deploy capital with an extended investment horizon when it happens.”

To be sure, waiting for it to happen could take a while. The longest stretch between 5-per-cent moves in the S&P 500 was eight years, between April 2000 and September 2008, data compiled by Bloomberg show. Applying that interval to now would push out the next one until 2019.

The last time stocks fell by at least 5 per cent in one day was August 2011. While the start of 2016 has been plagued with jarring moves in the world’s biggest equity market, the biggest single-session plunge so far was 2.5 per cent on Jan. 13.

Investors are skeptical they’ve seen a dip worth buying. The S&P 500’s bounce from a 21-month low on Jan. 20 was the slowest recovery after that sharp of a plunge in seven years, data compiled by Bloomberg show. Without a selloff powerful enough to encourage traders to jump back in, what’s been left is a volatile market with a lack of resiliency.

A bottom in stocks is hard to see, but the benefits of investing after a 5-per-cent drop aren’t, according to Colas. “That’s a key entry point that may seem like a stomach-churning path to the poorhouse but actually tends to turn a handsome profit over time,” he wrote.

On average, traders would get an annual return of 19 per cent if they bought the index at the close of a 5 per cent down day, data compiled by ConvergEx show. Of the 22 days that saw such plunges since 1957, only four produced negative returns over a year. After five years, gains total 75 per cent on average.

Take the one-day plunge on Aug. 8, 2011, when the S&P 500 fell by 6.7 per cent. The benchmark returned more than 25 per cent a year from that point, while 2011 as a whole saw flat returns and 2012 saw a 13 per-cent gain.

The environment is ripe for another one, according to Mr. Colas. The Federal Reserve is withdrawing stimulus and rising volatility may be putting off buyers. The year began with an average intra-day swing in the S&P 500 of 40 points, compared to 22.6 points last year and 16.5 in 2014.

Smaller dips like Tuesday’s 1.9 per cent don’t provide the same opportunities. When the benchmark falls about 2.5 per cent, which has happened 21 times since 1957, the average annual return is only about 7 per cent, according to ConvergEx.

“Bottom line, the market has proved resilient through decades of wars and financial crises,” wrote Mr. Colas. “Look at significant daily pullbacks as an opportunity to buy the market at cheap levels for long-term growth, and be ready with the capital to do so.”

Courtesy: The Globe And Mail

6 Comments Categories: Investing Tips

6 Replies to “A 5% one-day drop in S&P 500 is ‘overdue,’ says strategist”

  1. Ho !!!! This 5 % sounds like a lot of fun !!!!!
    Do you think that they would activate those …breakers ….
    ….like in China ????

  2. in other words… if you bought the day before, you would most likely be up 14% ( 19-5) after one year, then 70% (75-5) after 3 years, according to the stats of the author. what was not included was any dividend payments. if you are in cash waiting 3 years for a drop, you are losing 3 years of dividend, which will most likely be more than enough to make up for the extra 5% by waiting. timing is the key…or is it…

  3. The S&P dropped 5% on Friday October 16, 1987. On the following Monday it dropped another 20%. Initially the economy was unaffected. Excesses continued to build and then there was a global depression in the early 90s. There is likely a lot of current excess that needs to get burned off. Save up. But I digress.

  4. Let me That’s why I put in my limit orders every night before I go to bed. I don’t want to miss another day like in August 2015 when the DOW craters 700 points.

  5. Earnings on the S&P 500 to date have been light for 4th quarter 2015 or guiding lighter into early 2016. It is not unreasonable to expect the index to drop to 1650-1700 based on a compression of p/e and expected 2016 earnings which from current levels is about 10-13% drop. Remember when earnings drop so does p/e as investors become more cautious. It would be better to have a bigger drop in the 5% plus range to settle the market and help define a bottom rather than a creeping drop like we saw in January. Will it happen, who knows? However since it has been a while it increases the likelihood as suggested by the author. Right now the market is definitely declining and not yet likely to have bottomed.

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