S&P 500 Plunge? Not (Always) Terrible
James Picerno | Jan 28, 2015 06:02AM ET
The stock market crashed; it collapsed; it tanked. Or as MarketWatch.com described yesterday’s 1.34% decline: “S&P 500 plunges from major resistance.” Oh, my… that sounds serious. But before we dig a bunker, let’s put yesterday’s price action into perspective. Was the slide unusual? Well, maybe, although “unusual” depends on your expectations for volatility. What does that mean? Depends on who’s speaking. But no worries. A quick tour of market stats will (hopefully) clear up the ambiguity.
Let’s start with the incidence of daily declines of 1.34% or more. Crunching the numbers shows that the S&P 500 has suffered daily setbacks of yesterday’s magnitude (or worse) around 5.9% of the time since 1950. Over the past 10 years, daily downturns of 1.34%-plus have pinched Mr. Market just slightly less than 9% of the time.
Using history as a guide, we’re well advised to expect daily market moves that fluctuate between a daily 2% loss and a 2% gain as a routine affair. Charting the last 1,000 trading days for the S&P 500, for instance, reminds us that changes within this band are as unusual as finding gum on New York sidewalks.
Sure, yesterday’s drop could be the start of something ominous, but it could just as easily turn out to be Mr. Market’s sound and fury that signifies nothing. Don’t misunderstand: price trends are important and worthy of close attention. But unless your trading horizon is the next 20 minutes, daily data in isolation is usually random noise.
One more chart drives home this point. Comparing actual daily returns since 1950 (black circles in chart below) with a random distribution (red line) reveals that the bulk of the changes within the +/-2% band look like noise. It’s at the extremes that daily performance becomes something other than random–i.e., the black dots move far away from the red line, aka fat tails.
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This profile of market history doesn’t offer much in the way of sexy headlines, but sometimes it’s useful to focus on the cold, hard facts vs. the drama… if only as a brief diversion from the crowd’s regular obsessions.
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