I will keep this update short and simple. It is likely that the investment markets experience an outlier day this week. Given the impending election, voters and markets are on the edge of their seats.
Outlier Day Definition
An outlier day is classified as any trading day that is beyond +/-1.50%. This daily fluctuation is a statistical number based on two normal bell curve standard deviations. During a bull market, outliers occur infrequently, and markets will usually only experience 5 outliers over the course of 100 trading days. In bear markets, outlier days occur much more often. Right now, markets are in a “bullish” state. An outlier day during a bull market usually occurs as a reaction to some piece of news or event, such as an election.
Outlier Day Statistics
· Since 1950, the number of outlier days to the downside (897) is nearly equal to the number of outlier days to the upside (886).
· The S&P 500 has been in one of Canterbury’s “Bull Market States” 64% of the time. Only about 1/3rd of all outlier days occurred during a Bull Market State. During a Bull Market, you can expect an outlier day 5 times in 100 trading days. In a non-Bull market (bear or transitional), outliers every 4 or 5 trading days.
· Historically, October has seen the largest number of outlier days compared to any other month.
Why Could we see an Outlier in the Coming Days?
#1: Low Volatility
Historically, October typically sees the most significant daily fluctuations. Up until Halloween, this October was an anomaly. Not only had the month not seen an outlier day, but it had not even experienced a single trading day beyond +/-1.00%. By all accounts, that is low volatility in what is normally a volatile month. Having condensed fluctuations is similar to compressing a spring. The more the spring is squeezed, the more pressure that gets built. The market will relieve that pressure with outlier days.
#2: Halloween was an Outlier
Finally, on Halloween, the S&P 500 experienced an outlier, declining by almost -2%. Perhaps this relieved some of the pent-up pressure from low volatility, but studies show outliers typically occur in clusters. It is normal to see 2 or 3 outlier days in relative succession. The direction of the move is a coin flip.
#3: Election Results Could Surprise the Market
There are numerous news events that can cause an outlier day during an upward trending market. News pundits attributed Halloween’s market outlier to “investors assessing earnings season for big technology companies with growing skepticism (WSJ).” If markets experience an outlier this week, it will likely be attributed to Tuesday’s election results.
If you're asking yourself what result will yield an outlier to the upside or downside, well, I do not have a direct answer. News events drive market noise, and that noise is often unpredictable. When Donald Trump won the 2016 election, many Hedge Funds and Economists alike predicted a market catastrophe. The Monday before the election, the S&P 500 rose +2.22%. Tuesday night, the Dow Jones fell 700 points overnight following the election results. To the surprise of most, the Dow closed the following day up +1.40%.
Whoever wins or loses the election is not a black and white response for the markets. If markets expect Trump to win (as the betting odds indicate), the market could decline because it “buys the rumor and sells the news.” On the other hand, a Kamala victory could surprise the market and cause it to rise.
Bottom Line
Regardless of what happens on Tuesday, there is a heighted probability of an outlier day, whatever the reasons may be. The direction of any potential outlier is unpredictable and has the same odds as a coin flip.
Keep in mind that most outliers during a bull market will see the market revert to normal fluctuation. For example, following the outlier on Halloween, you might see an outlier to the upside, erasing the losses as if nothing happened.
On the other hand, if markets begin to get more volatile, having an adaptive portfolio management process is crucial. The portfolio that works in a bull market is not the same portfolio built to withstand a bear market. It is important to have a process that can adapt its holdings and allocations as market environments change.
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