Stock market declines really happen a lot more often, shows this chart

Investors should perhaps become more accustomed to the stock market slumps similar to those that rocked the markets last week, surpassing the Dow Jones stock market index by more than 830 points Wednesday and leaving behind them. 39; first-order indicator and the S & P 500 index performing poorly since February.

They could also console themselves with the story, which also indicates that when they occur, a market trough is usually not too far away.

"If the sudden market downturns seem to occur more frequently than in the past, it's not just you," writes Pravit Chintawongvanich, equity derivatives strategist at Wells Fargo Securities, in a research note published on Monday. .

These sudden explosions of volatility have become more and more frequent in recent years, he said, highlighting the graph below.

The chart shows the days when the volatility ratio over 5 days over 3 months exceeded 3. "In other words, there is a huge surge of volatility compared to the norm," wrote Chintawongvanich. Since 2007, six such events have occurred, compared to only five in the previous 50 years. In fact, a 22-year period between 1964 and 1986 did not see one, he noted.

The October 10 sale saw the S & P 500

SPX, + 0.10%

down 3.3%, while the Dow Jones fell 831.83 points, or 3.2% – the largest one-day declines for everyone since February 8th.

The most striking thing about almost all of these events, he noted, was that market funds generally only went a few percentage points, which resulted in a slight decline on average. And in almost all cases, stocks were higher in the next three months.

But he also said things have improved, he said, with volatility generally realized higher after the event.

Chintawongvanich has attempted to explain why such volatility eruptions tend to mark a trough or at least a near-trough. He concludes that, most likely, it is because progress flows are more about liquidity – and its temporary absence – than any sudden change in market fundamentals. He writes:

If the market suddenly has a huge sale, 1) the fundamentals of the economy have changed instantly from yesterday, 2) the markets have collectively decided that stocks are much riskier than they were yesterday, or 3) more liquidity has been requested than the market could provide. It is unlikely that 1) the fundamentals are the case today – most people would agree that the fundamentals of the economy have not changed since last week. 2) A higher risk premium could possibly be the case – after all, if 10-year yields are higher, perhaps the risk premium of equities should be higher, there are concerns about the growth of profits, margins, trade, etc. But the real reason is probably 3) the lack of liquidity, or more precisely the fact that the sale for 1) and 2) has led to a problem with 3). In any case, if inventories are down because more cash is required than the market can provide, they should rise once the demand for liquidity is gone. This should be true whether liquidity is demanded by "portfolio insurers", CTA robots or good old human traders.

But why are these events more frequent? Chintawongvanich said that it was possible that the market structure has changed. This could come on the demand side, via the increasing use of options and related products and strategies, or on the demand side, from the rise of high frequency trading and the use of high-frequency trading. other developments.

Whatever the reason, investors can at least feel reassured to know that everything is not in their head.