Are stocks at risk of a pullback?

The S&P 500 endured its worst day since April last Wednesday, with the Vix – Wall Street’s fear index – climbing the most in almost five months. After a big rally, is it time for traders to run for cover? While there were some grim headlines last week, such volatility is normal. The Vix spiked, but only from a very low level, and it remains below historical norms.

Nautilus Research found eight previous occasions where the Vix was mostly below 15 for a period of time and then popped above 15.5. Three months later, stocks were higher on all but one occasion; six months later, they were higher every time.

Returns were above average across both time frames. Wednesday may have seemed stressful because it had been more than two months since the S&P 500 suffered a one-day 1 per cent decline. However, these declines are normal – there were 17 such instances in the first five months of this year, notes market strategist Charlie Bilello, during which time indices roared higher.

The Carson Group’s Ryan Detrick notes that since 1980, there have been 27 occasions where the S&P 500 suffered its first 1 per cent decline in more than two months. A year later, stocks were higher 26 out of 27 times, enjoying average returns of 14.8 per cent. Of course, stocks may still retreat. Historically, the August-September time frame has been the weakest two-month stretch for the S&P 500, notes eToro’s Callie Cox.

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Negative seasonality as well as “toppish” technicals are also noted by Barclays. Detrick, usually bullish, also cautions about seasonal weakness, adding a 5 per cent pullback after a big rally would be “perfectly normal”. Stocks don’t go up in a straight line, but it appears most observers expect any decline to be a fleeting affair.