'Same Old, Same Old': History of 5% Pullbacks Shows This Time Is No Different

While market players are conditioned to believe pullbacks won't last long, there is great danger that they will be trapped if a turn does not come quickly.

Since the market low in March 2009, the S&P 500 has 26 times had corrections of more than 5%. According to data compiled by Charlie Bilello, on average, the correction has lasted 26 days and the average decline has been 7.9%. In each case, except for the current one, the market has gone on to hit a new all-time high.

Only twice in the past 11 years has the pullback in the S&P 500 exceed 20%. Once in the fourth quarter of 2018, when the unwinding of the "short volatility trade" caused a sharp decline, and once in the summer of 2011, when U.S. debt was downgraded and fears of a recession bubbled up.

Most of the 25 previous times the S&P 500 has dipped, the corrective action was shallow and has not lasted very long, so it is not a big surprise that market players are already looking for a bounce to occur. According to Bespoke Investment, the last 10 times the S&P 500 has fallen by more than 2%, it had just minor losses the next day. When the decline occurred on Monday, there has been a bounce of around 1% on Tuesday which is why the phrase "Turnaround Tuesday" has become popular.

What all this data tells us is that market players are well-conditioned for dips to be short-lived and to eventually produce new all-time highs. Each time someone has wondered in the last 11 years if it was different this time, the answer has been no.

On Tuesday morning, there is talk that the 1000-point drop in the DJIA on Monday was an overreaction. There was no great increase in the number of COVID-19 cases overnight and so far the U.S. seems to be immune from any expansion, but new cases are bubbling up and the economic damage is becoming more certain.

Typically, when the markets are hit as hard as they were on Monday, they will retest lows after a brief oversold bounce. One thing that was very unusual about this drop is that it occurred when the indices are so close to all-time highs. Typically, the indices stay resilient when they are close to highs and only after a period of drifting lower does the real selling pick up. When the indices are near highs, there tends to be stronger support as most market players are conditioned to be rewarded for buying dips.

At this juncture, I'm not trustful that a bounce will last long. Because of the data discussed above, there is likely to be a quick try to bounce the indices, but if and when it fails, there is going to be a sharper decline because there isn't enough negativity yet.

My game plan is to continue to be very patient with any long buys right now, but to start looking harder at those stocks that are already well off their highs and near support.

I've covered some index shorts, but will look at remounting them as yesterday's lows come into play or if the bounce takes the indices too high and into resistance areas.

I'm not convinced that the worst is over, but it is understandable why many market players view this as just another short-term correction that will end quickly. I'll be intently focused on the price action for clues as to how this will unfold.

At the time of publication, Rev Shark had no positions in any of the securities mentioned.