As March comes to a close, we now see that it indeed came in like a lion and went out like a lamb. Month to date through Mar. 10, the Standard & Poor's 500-stock index declined 4.3% to 1273.37, bringing the total decline from the Oct. 9, 2007, peak at 1565.15 to 18.64%. Since Mar. 10, the "500" advanced 3.3% to 1315.20 through Mar. 28.
Reasons for this reversal of fortune, in our opinion, include the prospects that the first-half weakness in S&P 500 earnings per share will likely mark the bottom of this earnings contraction, and the realization that the Fed will do whatever it can to stabilize the credit and financial markets. In addition, investors may be wondering whether the equity market is bottoming along with consumer confidence. These words of future comfort don't mask the beating investors took during the first quarter of 2008, however, as the Nasdaq fell 14.7%, while the S&P 500, MidCap 400, and SmallCap 600 declined 10.4%, 10%, and 8.4%, respectively.
Within the S&P Composite 1500 index (our U.S. total market index), all 10 sectors posted year-to-date declines in price, ranging from tumbles of 4.2% or less for the Consumer Staples and Materials sectors, to slumps of 16% or more for the Information Technology and Telecom Services groups. Finally, despite double-digit advances for the Trucking (+14.6%), Homebuilding (+12.3%), and Oil & Gas Exploration & Production (+11.6%) subindustries, 117 (85%) of the 137 subindustry indexes in the S&P 1500 fell during the quarter, led by declines in excess of 30% for Oil & Gas Refining & Marketing (-30.6%), Commodity Chemicals (-33.2%), Education Services (-35.2%), Wireless Telecom Services (-37.6%), Managed Health Care (-38.7%), and Consumer Electronics (-38.9%).
With such results, it's no wonder price volatility has been on everybody's lips. Adding to this concern, the S&P 500 has registered 16 one-day declines of 2% or more in the past 12 months, which is four times the annual average since 1950, and on Mar. 18 the "500" surged 4.24% to record the 17th-largest one-day increase in nearly 60 years. What investors are now wondering is if this wide variation in volatility is a harbinger of even worse things to come.
Possibilities of Volatility
If history is any guide (it's never gospel), it does not appear to us that volatility has become severe enough to signal the worst is behind us. Whenever the three-month average of the S&P 500's daily high-low volatility has peaked above 2.55% (two standard deviations above the daily average of 1.45%), the S&P 500 has been about a month away from the bottom of a bear market or sharp and swift corrective action. Since 1962, the bottoms of the bear markets of 1962, 1970, 1973-74, 1987, and 2000-02, as well as the corrective actions of 1980 and 1998, were identified as being close at hand by a spike in trailing three-month daily intraday price swings for the S&P 500. And while this volatility measure did issue a false signal one year into the 1973-74 bear market, it successfully identified the end was near for the five worst market declines since 1945, which declined an average 39%.
Today, the trailing three-month volatility index is below the threshold that would signal a bottom is near. There are two ways one could read this: First, we are in a sideways trading period that will be followed by further downside action to be accompanied by a pickup in volatility. Only after the volatility index has peaked above the 2.55% level would we feel more confident that a bottom was close at hand.
The other possibility is that, like the more slowly developed and less volatile and deep bear markets of 1966 (which fell 22%), 1982 (-27%), and 1990 (-20%), this corrective action may end up being as subdued as these three, which, as a whole, declined an average of 23%.
The Worst May Be Over
S&P's Investment Policy Committee believes that from economic, fundamental, technical, and historical perspectives, the second scenario is most likely that the worst is behind us.