Earlier this month I talked a little bit about the mean reverting bounce associated with a 3% one day drop in the SPX in VIX Spikes and SPX Drops Are Not Necessarily Two Sides of the Same Coin.
Yesterday, we had a 4% drop in the NASDAQ-100 (NDX) and, not surprisingly, the 33 year historical record of 4% drops in the NDX suggests that a bounce is again likely to follow yesterday’s pain. What I found particularly interesting is that the bounce following a 4% NDX drop has a lifespan of only a month or so before any incremental gains revert back to the historical norm. In fact, the maximum post-bounce advantage peaks at about ten trading days, then slowly starts to erode. Looking at data from all 108 of those 4% drops, average performance begins to drop after the tenth day and is decidedly bearish during the period of 2-6 months after that 4% drop.
Part of the reason for this statistical bull trap is the relatively high number of 4% drops in the NDX that occurred during the 2000-2003 period (accounting for 75% of all 4% drops during the 33 year period under study), which lends a bearish cast to the data.
So what about the IBD bag? Well…someone decided to start me on a trial subscription to Investor’s Business Daily about a week or two ago. I scanned the paper for the first few days and noted with a smile that it came wrapped in a green plastic bag. Yesterday the paper arrived in a yellow bag and I wondered if this was some sort of signal from Bill O’Neil or God or perhaps both. Of course, the markets proceeded to plummet on that yellow bag day. So today I look outside in eager anticipation to see what color the bag is and it’s yellow again. This time the markets are only down about 0.7%, but the day is young. I wonder what it means when the paper arrives in a red bag?