Here’s Why You Should Celebrate the Sell-Off
This week started badly.
The financial news ran with the story that Monday and Tuesday’s drop was the worst two-day streak for stocks since 2015.
Even more historic, the big S&P 500 index opened down 2.4% Monday morning — the worst overnight gap down since February 1982.
While it might be jarring to see back-to-back days of selling pressure in a market that’s been going up virtually nonstop, the reality is that most investors should be celebrating the sell-off.
Looking back to 1990, there have only been 15 instances where the S&P 500 gapped 1% lower — or worse — from where it closed the session before.
But historically, those ugly sessions have provided stellar buying opportunities: On average, the S&P has ended 10.1% higher six months later.
The chart above shows the stock performance that’s followed every such instance since 2000. A couple of important takeaways — only one of those instances ended lower six months later. And only the financial crisis of 2008 gave us a situation where stocks spent a prolonged period in the red following a big opening gap.
My point is that, historically, the awful kickoff we experienced this week hasn’t been the start to a bigger bear market…
It’s been a buying opportunity!
That’s stayed pretty consistent, too. If we expand our search back to 1970, the average gain six months after a 1% or worse start to a trading session widens to 11.7%.
Does that mean you should be aggressively buying right now?
No. Not yet.
Looking back at the chart above, similar instances have typically endured negative returns for a few weeks after the big gap lower. The optimal time to buy has typically been 20–40 days after the event.
Typically, whatever spooked the market will be worked out by then.
If the pattern repeats in 2020, it’ll mean that late March will be the best time to buy…
And that the S&P 500 will be hitting new all-time highs again by spring.
Corrections are a normal part of healthy bull markets. And at this point, the data don’t point to this week’s selling pressure being anything out of the ordinary — even if it’s likely to take a couple of weeks for the whole correction to play out.
If anything in the data changes, I’ll let you know. Watch this space.
Jonas Elmerraji, CMT