During times of decline, investors naturally become worried whether further downside is likely to follow. With NDX falling for the first time in a while, how likely is it that we see additional decline, and how strong has the market been in similar situations?
The last several months have been exceptionally kind to stocks, but action so far in November saw the end of once-in-a-decade streaks without notable downside. Prior to this week, the Nasdaq-100 (NDX) closed within 5% of all-time highs (ATHs) since May, marking the end of the 3rd longest streak ever for the index. During times of decline, investors naturally become worried whether further downside is likely to follow. With NDX falling for the first time in a while, how likely is it that we see additional decline, and how strong has the market been in similar situations?
There have been 46 other instances in which the Nasdaq-100 has declined 5% to 10% from all-time highs since ~1993. Of those declines, 25 instances saw the index decline by more than 10%, meaning there’s historically a 54% chance the index hits correction territory before setting ATHs again. Meanwhile, it’s taken an average of 6.6 months to get back to ATHs from our current range. However, the length of recovery is skewed by the longest ATH drought for NDX, which lasted over fifteen years. The median 5% pullback for NDX has lasted only 1.5 months, so history suggests a 50% chance of returning to highs by early January.
Additionally, previous instances of a 5% decline have seen strong forward returns from those instances. Specifically, NDX averages a 15.3% six-month return and 24.3% one-year return in those occasions, which are each around 7% better than the average periods for the Nasdaq-100. Overall, there’s a trend of improved performance following declines in NDX, as each bucket with a decline within 30% of ATHs sees one-month to two-year returns greater than the average period. However, returns start to fall after declines greater than 30%, with the 15-year drawdown of the index dragging down the average in the limited sample. Note that the 2000 decline went from 24% to 32% downside, skipping the 25% to 30% basket.
Looking at the Point & Figure chart for the Nasdaq-100 further confirms a positive outlook for the index. NDX did move lower than its previous column of Os, causing a sell signal, but the weight of the evidence is still favorable for the index. The first sell signal after an extended streak of buy signals is often just a head fake, and support for the index now lies closely at 22,200. Additionally, the Nasdaq-100 is no longer in overextended territory, with NDX trading right at its 10-week moving average after possessing an overbought/oversold (OBOS) reading above 80% at the end of October. Given the index’s positive trend and long-term relative strength, its technical picture suggests the pullback might be a buying opportunity for the Nasdaq-100 and other growth stocks.
The Nasdaq-100 isn’t the only major index to break a streak, as the S&P 500 (SPX) was within 3% of all-time highs since early June before ending its run this week, capping off the 7th longest streak for the index since 1950. While SPX has yet to fall 5% from its ATH, the index is within striking distance of doing so. If the S&P 500 were to reach that level of downside, should we take that as a warning or another sign to buy the dip?
There have been 67 other instances in which the S&P 500 has declined 5% or more from all-time highs since 1950. Of those declines, 23 instances (1954 & 1997 jumped straight to a 10% loss) saw the index decline by at least 10%, meaning there’s roughly a 54% chance of a correction before setting ATHs again. On average, it has taken 6.6 months to return to ATHs, which suggests the index could recover on average by September, with the median outcome looking closer to late January.
Like NDX, SPX also sees its intermediate-term returns boosted following a dip, as pullbacks up to 30% see above-average returns across one-month and six-month periods. However, it isn’t until the S&P 500 declines by 15% that one-year and two-year returns start looking significantly stronger than usual, meaning that smaller pullbacks can be a near-term tailwind but don’t necessarily result in long-term strength for the index.
The technical picture for the S&P 500 is still mostly positive, albeit slightly weaker than the Nasdaq-100. SPX traded on four consecutive buy signals prior to its sell signal this week, meaning the move lower could be a head fake as stocks consolidate from overbought territory. Additionally, the index also sees support at 6,660
One thing to keep in perspective is that downside in stocks is not just a risk, but an inevitability. Pullbacks are a healthy part of any bull market, as stocks can’t rise every single day. This week marks the sixth time in two years that NDX has seen a 5% decline from ATHs, but despite that, the index is still up 55% over that span. The important thing for investors to understand is that the markets move higher over time despite these temporary setbacks.
