By Saqib Iqbal Ahmed
NEW YORK, March 20 (Reuters) – Stock markets are facing their sharpest volatility in months as the S&P 500 is down more than 5% from its record high for the first time since November, leaving investors to weigh whether this represents a buying opportunity or the onset of a more severe pullback.
With the U.S. and Israel locked in a deepening conflict with Iran and no immediate resolution in sight, U.S. stocks have slipped in recent weeks as rising crude oil prices revive inflation fears.
Drawdowns of 5% are not rare, with some 60 occurring since the benchmark index’s launch in 1957, according to a Reuters analysis of LSEG data. The S&P 500 closed down 5.1% on Wednesday.
“People look at this and say, oh, you know, we’ve seen pullbacks like this before … they usually work out OK,” said Steve Sosnick, chief strategist at Interactive Brokers.
History offers both reassurance and warning: most 5% pullbacks present buying opportunities and recover quickly, but a significant minority deepen into corrections – or worse, full-blown bear markets.
Much depends on how long the Iran conflict lasts, whether the energy shock from soaring crude prices persists, and its ultimate knock-on impacts on economic growth in the U.S. and abroad.
NOT UNCOMMON
The S&P 500 has registered a drawdown of 5% or greater roughly once every 14 months over the last seven decades.
Out of the 60 episodes where the S&P 500 first slipped at least 5% below its then-record high, only 22 went on to fall 10% or more before a new high was set, while the other pullbacks remained shallower.
An even smaller subset, some 10 of them, saw the index keep falling to log a 20% or worse drop, technically termed a bear market.
One aspect of the selloff favoring stock market bulls is how long the benchmark index has traded in a narrow range since logging its most recent new high in January.
“History shows – but does not guarantee – that when the S&P 500 churns below its all-time high for an extended period before falling into a pullback (a decline of 5.0% to 9.9%), any subsequent decline does not exceed 20%,” Sam Stovall, chief investment strategist at CFRA, said in a note.
BUYING OPPORTUNITY
History suggests 5% pullbacks are typically good buying opportunities. In only 14 of the last 59 instances was the S&P 500 lower a month later, with a median gain of 2.44%. That’s well above the median 1-month forward return for the S&P 500 since 1957 of 1.09%.
The median returns three and six months out were 4.82% and 7.01% following the first slip below the 5% mark, compared with median forward returns of 2.59% and 4.97% for any given day since 1957.
Still, so far, investors have been cautious about scooping up battered stocks.
“Our customers still tend to be net buyers of stocks, but not nearly as aggressively as we’ve seen through other flushouts,” Sosnick said.
“The conviction is less intense … the level of buying is less intense.”
BEWARE THE BULL TRAP
While 5% market pullbacks may be routine, investors looking to take advantage of stocks on sale would do well to keep in mind that whether they make quick gains depends entirely on how shallow or deep the pullback becomes. The difference is dramatic in terms of how long they have to wait for new highs.
When the market steadies before dipping 10% from the record high, the recovery to a new high takes a relatively quick 37 trading sessions on average. When the index slips more than 10%, the average sessions to recovery balloons to 448 sessions, according to a Reuters analysis.
For now, investors appear to be in wait-and-watch mode, with various market volatility measures elevated but well short of levels touched at market bottoms.
“Part of this can be chalked up to investors having hedged any further downside, so not in panic mode,” Jim Carroll, portfolio manager at Ballast Rock Private Wealth, said.
(Reporting by Saqib Iqbal Ahmed; Editing by Megan Davies and Anna Driver)
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