Putting the Sell-Off in Context
Featuring Jessica Rabe
Published on: August 7th, 2019 • Duration: 14 minutesJessica Rabe, co-founder of DataTrek Research, breaks down the historical significance of Monday’s sell-off. In this interview with Alex Rosenberg, Rabe explains why a 3% move, down or up, is relatively common outside of this year’s low volatility environment. She also provides the four buy signals that investors should watch out for at this point. Filmed on August 6, 2019.
ALEX ROSENBERG: Welcome to Trade Ideas. I'm Alex Rosenberg, here with Jessica Rabe, co-founder of DataTrek Research. Thanks so much for coming in, Jessica.
JESSICA RABE: Thank you for having me.
ALEX ROSENBERG: Sure. So, you're here because yesterday was one of the, I think the worst day for stocks 2019, down just about 3%, the S&P 500. We're recording this in the morning, bouncing back a little bit, but we'll see what happens through the rest of the day. But you've done some really interesting research on down days in particular, what down days tend to mean for stocks over the next week, over the next year. So, maybe you can help us figure out a little bit about how investors should think about down days like this and how to allocate going forward?
JESSICA RABE: Of course, yeah. So, yesterday was almost down 3%. That's actually not particularly uncommon when you look back in historical terms. It really takes a down 4% day on the S&P 500 when you can really find an investable entry point. So, we went back and we looked at all the down 4% days over the past 60 years, which is the full data series for the S&P 500, and what we found is over the next day, it's playing out how it is actually today, you pop a little bit, maybe 100 basis points higher. The next month, you're actually flat, but over the next year, you're actually up 20%. So, I would look for more volatile days, not so much a down 3% day but actually down 4% day where you can actually buy at the close and find an investable entry point that you're up on average early next year 20%.
ALEX ROSENBERG: This is coming in the context of part of the maybe the reason that this day seems so shocking is it's in the context of a very still pond and then you get this rock tossed into it. But normally, it's a bit more of an ocean current to use a tortured metaphor here, but what I'm trying to say is that we've had very little volatility this year in comparison to years past, I know you've taken a look at that as well.
JESSICA RABE: Yeah, that's very true. It's been actually very little volatility, which is really unusual to be mid to late cycle where we are economically. So, if you look back in history, there's usually 53 days in which the S&P 500 rises or falls by 1% or more, of 1% day every week of the year. This year, there's actually only been 20. So, the Q1 average is 13. And the Q2 average is 13. But there are only 11 in Q1, there are only seven in Q2, running very much under pace, even over a month into the Q3 where there's again 13 on average, there's only been two. So, actually, what you saw yesterday was more healthy market churn.
ALEX ROSENBERG: And this market trend, do you think that this could lead to a period of more, no closer to the average or even above average volatility? Is that just volatility tend to cluster like that. And so, you wouldn't be surprised to see more 1%, 2%, 3%, even 4% days in the weeks to come.
JESSICA RABE: Absolutely. And you're seeing that today with the bounce back. So, as much as there's been 41 down 4% days over the past six years, there's also been 42 up 4% days. So, both unusual, but both tend to cluster together. And if you look back at the years in which that's happened, they all cluster together over- you think 2008 during the financial crisis, 2011 during the Greek debt crisis, the dot-com bubble in the early 2000s, 1987 with the market crash, there's actually as much as a down 4% day is a signal of an investable bottom. If you look at days in which the S&P has actually risen by 4%, they tend to cluster together. So, if you invested on a day where the clothes was up by 4%, the next year, it was up by 17% not as much as 20% as a down 4% days, but still up by 17% over the next year on average.
ALEX ROSENBERG: So, you basically have seen more volatility in since stocks rise more than they fall, the more volatility tends to lead to bigger returns just because stocks tend to rise and more volatility tends to bring you higher, I guess.
JESSICA RABE: That's right. And we expect more volatility to continue, more market churn as much as we're having a bounce today. If you look at the VIX, when it peaks or bottoms for the year back to when it was created in 1990, it's peaked the most in August. We've been warning our clients for a while that expect more volatility in August. And it sure happened very quickly at the turn of the month.
So, the VIX has peaked five times for the year in August, also five times for the year in October. So, it takes until November, where it starts to calm down, December is the quietest month of the year with actually bottoming eight times for the year. But August and October are historically variable too, especially August just due to even lower trading volumes, people went on vacation, et cetera. But we expect a lot more market churn the next few months because of that, and then come November, it should start to abate.
ALEX ROSENBERG: And these worries about August, this is very interesting, started toward the end of January as you were looking at what- because we obviously had a very good January after a very bad December. And you were looking at what good January tend to mean for the rest of the year. So, I'm trying to wrap my head around how you're able to predict the rest of the year base, month by month, but maybe walk us through some of what you were looking at then, and some of maybe why that methodology might work.
JESSICA RABE: Of course, so we had a terrible Q4 last year, December, as you said. So, January, we had a major snap back on- January was up by 7% return. That's one standard deviation above January's return going back over the past 60 years. So, we looked at all the Januarys in which the S&P, like this year, has risen by over one standard deviation above the January average, it's only been eight other years, it's very uncommon. So, then we looked at all the months after and how the S&P 500 has performed and we found that February through July, each month, that momentum carries through, so you're up higher through July.
Come August- and this fits with all the volatility data, you start to be down anywhere from 10 to 50 basis points from August, September and then down on average, 2.5% in those eight years in October. But then you also, again, fits with the volatility data where volatility abates and you start recovering November through December. So, on average, during the years in which January, the S&P 500 has returned above one standard deviation above the average, on a total return basis, those years have been up on average of 27%. And all of the years, except for one, were up by double digits. The only exception is 1987. And even that, people forget, was up 6% on a total return basis.
ALEX ROSENBERG: Yeah, that was a crazy year because the market just went up 20%, came down 20% in one day and then just ended flat from there.
JESSICA RABE: Yeah, and the playbooks worked really well this year. Just like the S&P 500 has been up from February through July for each of those eight years. It's worked every month this year, except for May because of trade concerns. We're down over 6% but we had a snap back in June. And that carried through July and now, of course, we're getting more volatility, but we do still expect to end of the year higher by double digit returns in line with that January playbook.
ALEX ROSENBERG: So, with that being said, should people just hide out until maybe November 1, 'til they're starting to put together their Thanksgiving plans? Or are there signs people can look forward to that maybe it is good time to get into stocks again? What signs would you be looking for?
JESSICA RABE: We actually last night put out on our blog, basically, four signs for an investable bottom after yesterday. Again, down 3% day or almost 3% day, not that uncommon. So, as much as it's been on volatile this year, and that seemed like a big move, it wasn't really- even the VIX only got up to 24 handle. That's within one standard deviation above the average of 19 since 1990, so not too crazy.
What we would look is number one, look for the VIX to go above 30. So, in Q4 of last year, the VIX did rise above 30. And that's really what got Fed Chair Powell's attention. And so, we're looking for number one, a VIX above 30. And then in the same vein of getting Fed Chair Powell's opinion, we want to really see Fed Funds Futures start pricing in over 50% chance of a 50 basis point cut in September. So, as of last night, after a bad market day, it was pricing in a 60% chance of a 25 basis point cut, well- no, a 40% chance of 50 basis point caught. So, we really think you need to look to when it gets to a 50% chance where markets are really convinced that they'll do it. So, that's number two.
Number three is already starting to happen. You really want to see the China's currency starts to stabilize, obviously the markets bouncing as of early this morning because of that. And then number four, we really think track Bitcoin, the price of Bitcoin, even if you're not invested in it, because over the past week, through this yuan devaluation news, it was up 24%. And it was up 7% within the first 24 hours of the yuan devaluation that's because of capital flight that it causes. And so, we think look for it to start declining and that will signal to investors- like China's doing now, stabilize our currency, but also to get more serious about really having trade talks with the US.
ALEX ROSENBERG: So, you're looking for a VIX of 30 or higher, which is another 3% down day could happen. Only you need a slight increase in the chance of a 50 basis point cut, China's currency to stabilize which at least, today, this morning, it's stabilizing a bit and then in terms of Bitcoin, you're looking for a- because those would all- I guess the first two would show maybe a bit of capitulation. The third would be fundamental ease and then Bitcoin, that's also around China and you want to see Bitcoin sell off a bit to indicate that more stabilization in China, less money fleeing China. Is that the idea?
JESSICA RABE: Right. Yeah. China's wealthiest citizens once say they believe that the yuan will stabilize more, though there won't be as much capital flight, fleeing the country.
ALEX ROSENBERG: Got it. Got it. So, all right. So, we could, by the end of the week, we'll see. It could all come together, these four things.
JESSICA RABE: Well, I think we'll certainly see more volatility, but we're so bullish on the year. And again, back to that August 2015 reference that I spoke about. So, from 2014 to 2016, earnings were pretty stagnant, like they are now. But you add interest rates fall from 3% down to 1.4%, right now, as of yesterday, we're down to 1.7% on the 10- Year Treasury. So, similar idea early in here, going down over the past year going from above 3% down through 2%. As long as you have falling interest rates, even though earnings are stagnant, we can certainly be up on the year from 2014 to 2016, the S&P was up a total of 28% even with flat earnings. So, even though we have flat earnings this year, and they've actually been pretty resilient given all the trade concerns, lower interest rates, and now, hopefully, the Fed will continue to ease and we do think we can be up on the year.
ALEX ROSENBERG: All right, so we're ending on a bit of an optimistic note and either way investors know what to watch out for those four signals. So, Jessica, thanks so much for joining us and I would just say, DataTrek Research does a lot of fascinating things. I love your guys' work. I love the research, the numbers and also some of the storytelling you put into it. So, anyway, congratulations on what you do there and thanks for joining us here on Real Vision.
JESSICA RABE: Thank you for having me.
ALEX ROSENBERG: So, while she's not particularly optimistic about stocks between now and November, there are four signs that Jessica is looking for which if all them hit serve as a buy signal. One, the VIX rising above 30. Two, the chance of a 50 basis point cut in September rising above 50%. Three, a stabilization of the Chinese yuan and four, eight sell-off in Bitcoin which will signal the end or Chinese capital flight. And for Trade Ideas, I'm Alex Rosenberg.