apprehensively anticipating a >1% drop

We were in this concerned position before, during the Obama Administration, but how quickly we forget.  As we then continued to carve out all-time highs in 2015, we often saw no more than a couple weeks go by before the market fell back at least 1% in a given day and allowed the markets to consolidate.  In fact we have popularly penned an article at other times of this quantitatively-enhanced market recovery, how waiting for declines can make one grow disillusioned.  To those who were hoping for something different, it is frustrating to see such low volatility, such as when market volatility hit a near-decade low, 7 days ago.  And yet again those short the market (e.g., liberal hedge fund managers) have been downhearted not seeing a 1% drop or worse, in now 81 days and counting!  Or since before this spectacular U.S. Presidential election.  We study the market history today to better communicate why volatility is so low, and provide clues as to when it will (and of course it eventually will) turn down for a nasty spill.

Since its founding in 1950, the S&P 500 has clocked nearly 17 thousand trading days, of which there have been only 22 other “no 1% drop” streaks, which also endured at least 81 trading days.  The previous one was pre-financial crisis in 2006, and that lasted 94 days. 

Also more than 2 decades ago in 1995, so skipping over the pinnacle of the internet bubble, there was a 105 day streak.  In fact as we see in this 67-year chart below, all of the other “no 1% drop” streaks of 105 or more trading days, occurred prior to 1995! 

This is reflective of the fact that earlier in time we typically had the lengthier of these record streaks, and they occurred far more frequently.  It hasn’t passed anyone’s attention –particularly among the entire Democratic leadership- that such low market volatility is finally again being enjoyed now, in the era of the Donald Trump.  Doesn’t he alone get credit for this?  We have noted that in some respects, the stock market is the most authoritative of popular votes.  In addition to streaks, the market tends to have many 3-month periods (the past 40 in fact), which included at least one 1% or worse drop.  So even without needing such a high 81-day streak as we have today, we see the market participants have gotten accustomed to highly regular pullbacks.

Of course we can see now that this streak of low volatility is very long in the tooth, though unclear if that means it still can’t go on for a little time longer.  Certainly those wrong so far aren’t likely due a break this week!  Markets can always frustrate mean-reversionists who demand simple probability relationships with data- and it has frustrated Big Data PhD junkies as well (link, link). 

We can also show in the chart below some interesting information, such as the lengthier the streak becomes, the weaker each trading day’s market move becomes.  In other words, not having the market drop 1% or so to “catch it’s breath” at a minimum, simply means it glides higher but weakly.  Those short the market to a small degree already know the pain isn’t that bad now, versus earlier in November through January, the engine of the Trump bounce.  We are of course see ourself now at the very right most of these box plots below, seeing that we are currently at 81 days.

Still this is not necessarily advice to short the market just yet, but rather remain vigilant that the market seems by many statistical characteristics to have reached a peak and is similar to a volcano ready to erupt, albeit the possibility for instead arriving at a very near-term false summit. 

We should also note the other characteristic we see is that, decades ago, the market tended to have lengthier streaks that were even slightly weaker each growing day as a streak carried on.  In this sense as well, the current streak of 81 days seems even more unusually long (similar to a multi-decade event).

The overall summary is that the stock market is clearly due for at least a small pullback.  Of course it’s coming but it doesn’t seem, from all of the statistical data studied on this website, to be coming much of this week.  But soon enough the pyrotechnics will be alive, and just when you think they are over, more larger fireworks will explode.  

Also note that harebrained derivative products to convey such a view, can lead to substantial losses.  So far folks have been lucky: the VXX and UVXY (link, link) were at 19 and 24, the day volatility we stated was at it’s lowest since 2007.  In the only 7 days since, the new prices for these are still at 19 and 24 (respectively), but with many chances for one to have sold out in-between at a loss.  And yes, that would be a loss, so hastily after the market hit a near-decade volatility low!