Pressure Drop

(Today’s accompaniment by Toots and the Maytalls in lieu of David Bowie and Queen)

Every so often a news report really gets me thinking.  Today I read a Bloomberg article that noted that the S&P 500 (SPX) has gone 350 sessions without a 2% drop.  That would put it on pace for its best streak since 2007.  The prior peak of 351 sessions occurred in early 2018.  Those dates should give some pause to those of us with a sense of market history.

The end of the record-holding streak occurred in February 2007.  That is when some market historians believe is when the cracks preceding the global financial crisis occurred, if not the beginning of the crisis itself.  When the streak ended, the Cboe Volatility Index (VIX) roughly doubled from 11.15 to a peak of 20.41 in a week.  To be fair, SPX didn’t peak until October 2007, two weeks after the Federal Reserve began reducing the Fed Funds rate from 5.25% amidst concerns about liquidity and bankruptcies.  Between then and March 2009, SPX fell over 50% and VIX had touched 89.53. 

The current, and soon to be former #2 streak (unless we unexpectedly plunge today or tomorrow), ended in early 2018.  That is a time that is etched in veteran options traders’ minds as “Volmageddon.”  During the two weeks from January 26^th to February 9^th, 2018, the S&P 500 (SPX) fell over 10% from a record high.  In that period, the Cboe Volatility Index (VIX) shot up from 11.08 to 29.06, touching 50.30 along the way. 

This is not to imply that disaster is lurking immediately around the corner.  The streaks mentioned above went on for years, just like the current one which began around the start of 2023.  Heck, the pre-GFC streak began in early 2003!  The length of a streak of this type tells us nothing about when the streak might end.  It could occur tomorrow or not for months or years.  It’s unknowable.

But the scary stories outlined above do point out something important about market behavior.  I have long believed that periodic selloffs, if not corrections, are like pressure relief valves for the market.  The longer the market goes without a decent selloff, the more the pressure builds within it, and the worse the ensuing blow-up. 

And bear in mind a phenomenon I have experienced for years.  When markets go up, few ask why.  They’re supposed to go up.  When they go down, even by a relatively minor amount, my phone rings.  A lot.  They’re not supposed to go down.

Let’s take this calendar year as a start.  There have been 135 trading days so far this year; 15 have seen days with SPX up moves of greater than 1%, while only 7 have been down by more than a corresponding amount.  One day, February 22^nd, saw an up move of more than 2%. 

Since the start of 2023, there have been 385 trading days; 51 with moves of more than 1% up and 35 with moves of more than 1% down and one additional +2% day.  Thus, we have seen an even lower rate of large downward moves so far this year than we did last year – especially since the last -2% down day on February 21^st, 2023.

While it is clear that the pressure seems to be building, we have no way of knowing what could cause even a minor blowup.  We noted last week that a heavy rotation out of the leading megacap tech stocks could itself be a potential trigger, and we have noted the various divergences that have created what I like to call “stock market Jenga”, where the market moves ever higher on a narrowing foundation.  It’s quite possible that a significant earnings miss from a megacap leader could cause a major downdraft.  It’s also quite possible that we can continue this way unabated for quite some time.  But having seen the outcomes of prior long streaks without selloffs, it seems hard to believe that this one will end benignly.