A lot of studies ask questions such as:
- What happens when the S&P 500 doesn’t decline more than X% in Y number of days.
- What happens when the S&P is less than X% below its all time high for more than Y number of days.
These studies are all asking the same question. “When the stock market is rallying and its volatility is very low, what happens next”?
The simplest way to gauge the market’s volatility is to use standard deviations. A market’s standard deviation as a % of its nominal value will be low if volatility is low!
Here’s the study that we’re looking at today:
- Calculate the S&P 500’s 20 day standard deviation.
- Divide the standard deviation by the S&P’s nominal value. This gives you a percentage that tells you how volatile the stock market is.
The S&P set a new record as of December 17, 2017. It went 123 consecutive days without its standard deviation exceeding 1% of the market’s value!
Ontop of that, the recent increase in volatility (standard deviations) is because the S&P 500’s rally has ACCELERATED. This is truly the beginning of an unprecedented melt up.
Here’s the data in Excel.
Now let’s loosen the parameters of this study.
Let’s take a look at the historical cases: what happens when the S&P goes more than 100 consecutive days with its 20 day standard deviation being less than 1% of its nominal value.
There are only 2 historical cases (this is an extremely rare signal).
- February 21, 1966
- January 27, 1994
- December 17, 2017 (current case)
February 21, 1966 (103 consecutive days)
This occurred just after the market topped. The S&P was in the beginning of a 23.6% correction!
January 27, 1994 (118)
This occurred at the very top before the market began a 9.7% correction!
This study is similar to other studies that we’ve done recently (here and here). The S&P’s next “small correction” will most likely be closer to -10% than -6% (the minimum definition of a “small correction).
However, there is one difference between the previous studies and this study.
- The previous studies suggested that the S&P will rally for at least 1-1.5 months before beginning a correction.
- This study suggests that the S&P will begin a correction immediately.
I’m inclined to believe the previous studies. This study’s signal came out on December 17, 2017. The S&P has soared since then, which makes the current case different from the 1966 and 1994 cases.