With volatility on the rise, we update our study that looks at the effect of missing the most extreme market days and how these days tend to cluster.
Volatility has been on the rise recently – the S&P 500 Volatility Index (VIX) has given six consecutive buy signals on its default P&F chart and broke above 20 in Thursday’s trading. Meanwhile, the S&P 500 (SPX) is on the verge of falling into negative territory for the year and the Nasdaq-100 (NDX) is down almost 1.5% (through 2/4). With the VIX rising and worries about a bubble threatening to upend the AI trade we thought this would be an opportune time to update our study that looks at the effect of missing the most extreme market days and how these days tend to cluster.
At one point or another, most of us have been told that a small number of the best market days account for the lion's share of any given year’s return. And therefore, the theory goes, investors should be always invested to avoid missing these days and the occasional sharp downturn is just a fact of life. Purveyors of this sentiment seemingly view these extreme days as unconnected events that occur in a vacuum. But the best days often occur in close temporal proximity to the worst days and therefore if one were to miss the best days, one might also miss the worst days. The image below shows the best and worst days for the Dow Jones Industrial Average (.DJIA) since 1985. Note that three months – October 1987, October 2008, and March 2020 – account for half of the most extreme days in the last 40+ years.
So, is there any truth to the “best days” theory? If the good days and bad days are clustered together, would we be better off if we missed these whipsaws altogether? To answer these questions, we’ve examined a few hypothetical scenarios. The first is simply buying and holding the Dow from 12/31/84 – 2/4/2026, which would have returned 3,985%. The other three scenarios are summarized below:
Missing the Worst 20 Days - In the green table below, we applied the concept of perfect market timing and side-stepping just the 20 worst-performing days in the DJIA. No doubt about it, the performance would have dramatically improved to the tune of more than 17,000% better than the buy-and-hold option. Said another way, a $100,000 initial investment would have grown to more than $21 million since 1985.
Missing the Best 20 Days - Taking it to the other extreme, what if you had the bad luck to miss the 20 best historical days in the Dow? In the red table below, you'll find that missing out on the best days, but still suffering through the worst, resulted in an underperformance of approximately than 3,000% over the last 40+ years.
Missing Both the Best 20 & Worst 20 Days – Realizing that these extreme days typically occur in clusters, we have also shown what would happen if you were to miss both the best 20 days and the worst 20 days. Interestingly, side-stepping all 40 of these days provides a better return when compared to simply buying and holding. This hypothetical portfolio would be up 5,908%, outperforming the buy-and-hold scenario by about 1,900%.
What does all of this mean to an average investor? What good does it do to know that the most extreme days are clustered together and that, historically, you’ve been better off if you missed both the best and the worst of them?
Well, the most volatile periods have tended to come in down markets. This begs the question “What is a down market?” Some have quantified it using moving averages, another way to quantify it is using the NYSE Bullish Percent (^BPNYSE).
The 30%, and below, level has been looked at as the “green zone” on the BPNYSE, and we have historically seen some of the best buying opportunities come from below the 30% level; however, trips to these levels are often uncomfortable. One way to quantify the “uncomfortable” nature of the markets while the BPNYSE is at or below 30% is simply by looking at the market's standard deviation (or volatility). For starters, going back to February 1997 the BPNYSE has only spent about 5% of the time at 30% or below, while the BPNYSE sits between 30 and 70 a little more than 70% of the time.
While the bulk of the past 28 years has been spent between 30% and 70%, an outsized portion of the volatility has come below the 30% level. When the BPNYSE is between 30% and 70% the annualized standard deviation of the S&P 500 has been 17.15%; however, while the BPNYSE has been below 30% the standard deviation has been over 48%...almost three times as high. We can also see that while the "up days" outnumber the "down days" when the BPNYSE is in the 30-70 or 70+ level but when the BPNYSE is below 30 down days have outnumbered up days.
It may be hard to reconcile the idea that the BPNYSE being below 30% is a highly volatile state for the market, but it also offers some of the best buying opportunities. But, as the saying goes “the time to buy is when there’s blood in the streets” and blood in the streets means panic, which means volatility. Of course, it is preferable if you’ve managed not to be one of those bleeding.
Said another way, if you’re able to enter the market after panic has subsided you can generate some truly amazing returns coming off the bottom. However, it can be a risky proposition because these extreme up- and down-days are often clustered closely together. This was perfectly illustrated a few years ago as six of the largest single-day moves in history occurred in consecutive trading days from 3/13/20 – 3/18/20. On the other hand, if we were simply able to sidestep these periods of heightened volatility, on average, we would also come out ahead of a simple buy-and-hold strategy.
Currently, the BPNYSE sits at 48, right in the middle of the 30 – 70 range where it spends most of its time, suggesting we can expect average levels of volatility.
