A 5% One-Day Drop in Stocks Is `Overdue' to ConvergEx's Colas

  • Daily drops of that magnitude occur about every four years
  • Buying S&P 500 Index post-drop results in 1-year return of 19%

Here’s some advice for investors waiting to buy the dip: keep waiting until you can buy the sinkhole.

That’s according to Nicholas Colas, chief market strategist at ConvergEx Group, who says that based on historical averages the market is overdue for a “crater,” when the Standard & Poor’s 500 Index falls more than 5 percent in one day. There, investors will find the best buying opportunity, said Colas.

“These opportunities have arisen 22 times for the S&P thus far and occurred about every 2.5 years, or 4 years when excluding an abnormally choppy 2008,” Colas, a 25-year Wall Street veteran at ConvergEx, which provides brokerage and trading-related services for institutional investors, wrote in a note Monday. “Therefore we are overdue for another, which is not an unreasonable expectation given the heightened volatility this year. Make sure you are ready to deploy capital with an extended investment horizon when it happens.”

To be sure, waiting for it to happen could take a while. The longest stretch between 5 percent moves in the S&P 500 was eight years, between April 2000 and September 2008, data compiled by Bloomberg show. Applying that interval to now would push out the next one until 2019.

The last time stocks fell by at least 5 percent in one day was August 2011. While the start of 2016 has been plagued with jarring moves in the world’s biggest equity market, the biggest single-session plunge so far was 2.5 percent on Jan. 13.

Investors are skeptical they’ve seen a dip worth buying. The S&P 500’s bounce from a 21-month low on Jan. 20 was the slowest recovery after that sharp of a plunge in seven years, data compiled by Bloomberg show. Without a selloff powerful enough to encourage traders to jump back in, what’s been left is a volatile market with a lack of resiliency.

A bottom in stocks is hard to see, but the benefits of investing after a 5 percent drop aren’t, according to Colas. “That’s a key entry point that may seem like a stomach-churning path to the poorhouse but actually tends to turn a handsome profit over time,” he wrote.

On average, traders would get an annual return of 19 percent if they bought the index at the close of a 5 percent down day, data compiled by ConvergEx show. Of the 22 days that saw such plunges since 1957, only four produced negative returns over a year. After five years, gains total 75 percent on average.

Take the one-day plunge on Aug. 8, 2011, when the S&P 500 fell by 6.7 percent. The benchmark returned more than 25 percent a year from that point, while 2011 as a whole saw flat returns and 2012 saw a 13 percent gain.

The environment is ripe for another one, according to Colas. The Federal Reserve is withdrawing stimulus and rising volatility may be putting off buyers. The year began with an average intraday swing in the S&P 500 of 40 points, compared to 22.6 points last year and 16.5 in 2014.

Smaller dips like Tuesday’s 1.9 percent don’t provide the same opportunities. When the benchmark falls about 2.5 percent, which has happened 21 times since 1957, the average annual return is only about 7 percent, according to ConvergEx.

“Bottom line, the market has proved resilient through decades of wars and financial crises,” wrote Colas. “Look at significant daily pullbacks as an opportunity to buy the market at cheap levels for long-term growth, and be ready with the capital to do so.”

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