Tuesday, January 22, 2008

Historic Five-Day Declines in U.S. Stocks: What Happens Next

We're on pace this morning to be down over 10% on a five-day basis in the S&P 500 Index. I went all the way back to 1960 (N = 12,074 trading days) and examined what happened after historic five-day drops in $SPX.

To give an idea of how rare it is for stocks to drop more than 10% in a five-day period, we've only had 11 such instances since 1960. Five of the greatest five-day declines were registered on October 19, 20, 21, 22, and 23 of 1987. Two of the instances occurred on July 22 and 23 of 2002. So, really, we've only had six periods of negative five-day returns exceeding 10%:

October, 1987
May, 1962
August, 1998
September, 2001
July, 2002
April, 2000

On 10 of those 11 occasions, the S&P 500 Index was higher 10 days later by a very large average of 5.62%.

When I loosened the criteria and looked at all five-day drops in the average of over 6% (N = 83), we find that, ten days later, the market was up by an average of 2.8% (53 up, 30 down). By contrast, the average 10-day gain over the rest of the period was .29% (6870 up, 5121 down).

To be sure, a weak market can get weaker: Of the 83 occasions in which we had five-day drops of 6% or more, 14 drew down another 3% or more over the next five trading days. Five of those instances were drops of over 5%. By contrast, however, 40 of the 83 occasions were up over 3% over the next five trading days.

The takeaway is that periods of great short-term crisis have, on average, been periods of opportunity. If you look at those occasions of 10+% declines, all have occurred at times in which it would have paid handsomely to be a buyer for the long-term. That doesn't mean that there can't be further turbulence ahead, but--as a rule--selling into panic has lost investors money.


Euphoria and Panic in the Stock Market