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What has historically happened to the S&P 500 after a 4% one day drop?

Is this a correction or will things get worse for global stocks?

Warren Buffett once said "What we learn from history is that people don't learn from history". He was referring to fear and greed and the most common mistake repeated consistently - thinking that "this time it's different"! So is it different this time? I'm not sure that's the right question at this particular moment in time. As I wrote in my 2018 market outlook (click here if you haven't read it yet) back in January, there are lots of positives in the world and economic data is strong, however a correction was very much needed. That's a 'correction', not a crash. We are not in a recession so I don't see a draw-down of 20-30%, and there isn't a banking crisis or worldwide structural collapse so I don't think we'll be seeing 40-60% losses here. In December 2017 I had originally forecast a stock market correction could happen sometime mid year 2018, but advanced that to around Q1 in January after a buoyant "Santa Claus effect" and an even more positive January for global equities. It was needed, and has happened (a correction is technically defined as a drop from highs of 10%, which we saw just recently in the US and Japan, amongst others).

It seems I should have expected it even earlier. However I don't have a crystal ball. Likewise I cannot say with 100% certainty that we have seen a bottom and the bull market will resume. What I can say with confidence though, is that there are buyers in the market to support equities at these levels, and though whilst volatility will likely remain (which is good - we've had level way too low for the past couple of years), I believe we will see an upward trend again soon. Economic data is strong, and the positive fundamentals that were with us prior to this correction are still very much intact. IPPFA's Head of Fund Management Services, David Mok, wrote in his Investment Commentary (view it here) on the 6th of February similarly. "Currently, the economic data does not suggest anything structurally wrong with the global economy...the extent of this current drop will likely be in the vicinity of a 10-15 percent decline).

So back to 'history'. Whilst this is again no guarentee of what will happen next, and I've often quoted, (I've forgotten who - answers on a postcard please), that "the one thing history tells us, is that history doesn't actually tell us anything at all", it does give some positive food for thought. The below bar graph, courtesy of Bloomberg, shows that we could well see a return north of 14% from the S&P 500 still. The data shows how stocks react after a large fall. Specifically it is the performance based on the median return of the S&P 500 Index after a one day decline of at least 4% (which we have just witnessed recently) during non-recession years back to 1928.

Based on this, stocks tend to gain after one week of a 'crash' trading day, dip again and then subsequently resume the rally. Perhaps we are about to see stage 3 of 3, the rally resuming again!?! Perhaps...

That's my opinion anyway, but back to the facts, and let's finish on a positive note - valuations in some stocks are stretched, but in others, and in certain sectors and regions, value is still very much there. As I cited in my 2018 Outlook, emerging market, and particularly Asian stocks, still offer very attractive relative value. The MSCI Asia-Pacific index is trading close to 13 year low relative to the S&P 500 and on a price-to-book basis (for those that don't like looking at P/E ratios) it is the cheapest for 16 years. For the MSCI Emerging Markets Index to make up ground since peaking against US stocks in 2010, it would need to provide relative out-performance of around 125%. So there clearly are good medium-long term equity investments, just find the right ones and in the right areas. Either way, belt up, it'll be quite a ride!

Author: Ian Pryor

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