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The stock-market plunge triggered by the global COVID-19 outbreak shows investors are taking their cues from the 2008 financial crisis, but at an accelerated pace, according to one Wall Street veteran.
In a Monday note, DataTrek Research founder Nicholas Colas argued that while the coronavirus pandemic presents a very different threat than the financial crisis, a look at price action shows that investors are “locked in the same call-and-response feedback loop between financial markets and D.C. politics as in 2008.”
Colas argued that market participants are running the same “2008 playbook,” but at an accelerated pace because that prior crisis history is still fresh in mind.
For example, Thursday’s close on the Cboe Volatility Index VIX, +36.59%, a measure of expected volatility that some market observers refer to as a fear gauge, above 75 was directly comparable to the 2008 Friday-Monday sequence of 79.1 and 80.1 hit on Oct. 24 and 27, and the Nov. 19-20 set up of 74.3 and 80.9. In the first instance, the S&P 500 rallied 10.8% on Oct. 28. In the second, it rose 6.3% on Nov. 21 and 6.5% on Nov. 24.
“Rather than take two days to see a strong rally, as in the 2008 cases, we got a 9.3% bounce on the S&P 500 on Friday,” noted Colas, extending gains in the final hour of trading as the White House outlined initiatives to deal with the outbreak and Congress neared a deal on legislation.
“The speed and size of government’s response to the challenge will determine where investors price risk assets. And the volatility of those prices will play a large role in how aggressively lawmakers respond,” he wrote.
Investors certainly appeared to be looking for more from policy makers after stocks plunged in the wake of the Federal Reserve’s emergency decision on Sunday to slash rates to nearly zero and implement around $700 billion in asset purchases. The S&P 500 SPX, -8.13% and Dow Jones Industrial Average DJIA, -8.62% were down sharply after triggering circuit breakers that briefly halted trading at the opening bell. The S&P 500 remained down more than 5%, while the Dow was off more than 6%.
So what does a look at the 2008 playbook show?
Colas noted that it took 19 trading days to go from the S&P 500’s first 5% daily drop on Sept. 29 to the first 75+ VIX reading. This time it took only three days after the benchmark’s 7.6% drop on March 9. Following the market’s 10.8% bounce on Oct. 28, the index saw less volatility over the following five trading days, but then took a turn for the worse to fall 14.6% over the next two trading weeks, he recalled.
A two-day free fall took the S&P 500 down by a combined 12.4% to close at a 2008 low of 752 on Nov. 20 while the VIX saw a record close at 80.9. The index then rose 20% between Nov. 20 and the end of 2008.
So it’s no surprise that there hasn’t been much follow-through from Friday’s bounce. If the pattern holds, “we can expect the S&P 500 to first grind lower (the 15% aggregate decline we saw over 2 trading weeks in early November) and then wash out in a 1-2 day selling climax (the 12% drop of November 19/20 2008).”
That would put the S&P 500 at 2,028 based on Friday’s close at 2,711, he said, but emphasized that the exercise wasn’t a prediction, but an attempt at mapping out where things could go if the selloff continues to echo the financial crisis.
He also offered a caveat, noting that much of the remarkable volatility seen in 2008 came amid political wrangling over the crisis response from Washington.
“We can avoid a repeat of the worst parts of 2008’s market volatility if the U.S. government’s response to COVID-19 comes faster and more decisively now than then,” he said. “If it does not, the downside for the S&P 500 is right around the 2,000 level based on the math we’ve reviewed in this section.
