SPY Volatility and Bear Markets
Intro:
This is another little research study I decided to do on SPY comparing the market volatility from 2007 – 2008 vs the volatility between 2021 till 2022 and determining whether or not we are truly in a bear market.
It will look at the volume and volatility of SPY during these critical times in history. And the results are extremely interesting, so I encourage you to stay tuned!
Why does it matter?
Volatility generally refers to how quickly markets move and can signify a varying degree of risk. The more volatile = the more risk. We can see this pragmatically when we look at options. IV or implied volatility measures the degree of volatility inherent in a stock. Market makers, traders, hedge funds and financial institutions pay very close attention to IV levels during times of high volatility or key political, economic or organizational events. For example, earnings releases, major announcements, etc. can all cause the IV to sky rocket, because it is a time of great uncertainty and there is a heightened degree of risk.
So why is it helpful to determine the financial crises volatility vs volatility now?
Well, this is debatable, but for me, in my opinion, it is informative and reflective of the current socioeconomic conditions of the market. Is the market interpreting our current situation as similar or dissimilar to the financial crises? If it is similar, how? If it is dissimilar, how? But moreover, determine how far a stock is trading from its average price will tell us whether or not we are in a bear market. If a stock is trading BELOW its average, and experiencing negative growth, we would say that this is bearish and we are in a bear market. If it is trading at its expected growth, we would say that it’s a stable market. If it is trading BELOW its average and expected growth, then that is indicative of a bear market.
This is quite a powerful analyses to give us insight into how the market is interpreting our current circumstances, whether it is interpreting them with the same uncertainty as was present in 2007-2008 or if it is behaving differently owning to the different circumstances. Also, the 2007-2008 crises were a clear example of an unquestionable bear market.
How do we measure volatility?
Financial volatility is a difficult measure. Generally, volatility refers to the average amount a stock has differed from its mean over a specified period of time.
This is EXTREMELY important because, for this study, I obviously need to calculate volatility. And because I know volatility measures how far a stock deviates from its mean, it dictates to me the type of statistical test I need to apply to determine volatility.
In this case, I will need to calculate the z score of the stock. What a z score measures in statistics is the deviation from the mean. The z-score value expresses how many standard deviations from the mean a value is.
For this study, I will use the stocks high daily high value to calculate the z-score.
Volume: Then and Now
The chart below depicts the traded volume of SPY since its nascence in the 90s.
In this chart, we can see that SPY’s volume slowly increased from 1993 till around 2005, peaking in 2007 – 2008 only to slowly decline until roughly 2021, where it peaked again and then dramatically fell between 2020 and today. The peak of volume in 2008 can likely be explained by the huge amount of liquidations that happened across multiple financial institutions and investment firms. Otherwise, volume has, statistically speaking, maintained normalcy from 2009 until today, without any major peaks or tapers.
We can see how volume slowly increased over 2007 – 2008 in the chart below:
And the chart below shows volume from 2021 till currently
We can see some peaks in volume starting this year which correlate to the major sell offs we saw at the beginning of the year; however, not comparable to the 2007-2008 crises.
Volume conclusion:
We are not currently seeing the same, dramatic volume as we saw during the 2007-2008 financial crises. This is anecdotally explainable by the fact that the circumstances leading up to the mass influx of volume are completely different. We are not seeing mass collapses of financial institutions leading to liquidations of assets. What we are likely seeing here (there is no way to say this with absolute certainty), is some liquidation of assets from investors and institutions owning to the current economic uncertainty. But nothing comparable to what we have seen during financial and economic chaos. This I would interpret positively. It means we are not seeing massive liquidation of assets that signify an impending or occurring collapse.
Volatility:
The chart below shows the volatility from 2007 – 2008.
IN this chart, we can see that leading up to the collapse, stocks were trading roughly 1 standard deviation ABOVE their mean, indicating bullish sentiment and quite sizeable buying.
We then see, between the beginning of 2008 into June of 2008, stocks were flat. Trading at values roughly around their mean. After June 2008, stocks saw a dramatic decline and hard selling and ultimately ended up spending approximately just over 3 months trading below 3 standard deviations from their mean, indicating fast, rapid selling.
The chart below summarizes the volatility from 2021 – current
This chart is extremely interesting!
We see that stocks dropped roughly 2 standard deviations BELOW their mean at the start of 2021 (i.e. the COVID collapse), which slowly tapered off and then resulted in stocks trading roughly at 1 standard deviation from their mean between July 2021 and the start of December 2021.
In December 2021 we see stocks almost reach a trading area of + 2 standard deviations above their mean (i.e. SANTA RALLY!) only to see them return to trading roughly at their mean in January of 2022 and then resume trading 1 standard deviation above their mean until currently.
You may be asking, what is going on? Aren’t we selling off?
Yes! But!!!! As I have explained in a previous post titled “explaining bear markets mathematically”, SPY and the market as a whole underwent somewhat unnatural growth. We can see this so clearly in this chart. From July 2021 until the beginning of this year (January 2022), SPY was trading at + 1 standard deviation from its mean. That is almost 1 full year of the market trading ABOVE where it should have been trading. So, even though we are experiencing mass selling currently, we still have not brought the stock to BELOW its trading average.
Isn’t that insane?
Conclusion
So what can we say based on these results?
I will summarize the facts from this analysis:
• The current volume we are experiencing is less than the volume in 2007 – 2008. This indicates that the market is not liquidating to the extent that it was during the financial crisis. While there is still mass liquidation, it is not to the same extent as it was during the financial crises.
• While stocks have declined in value and have been selling off since the beginning of the year, the overall market still remains somewhat overbought and remains trading about 1 standard deviation over its mean.
• I would argue based on this data that we are NOT in a bear market currently, as the market is technically over-inflated and trading above its expected growth range. Not until the market reaches – 1 standard deviation from its average would I begin to stipulate that we are in a bear market, as that would be negative growth.
• The 2007-2008 financial crises were both fundamentally and pragmatically different than our current circumstances. The market is not behaving identically in any way.
This is another little research study I decided to do on SPY comparing the market volatility from 2007 – 2008 vs the volatility between 2021 till 2022 and determining whether or not we are truly in a bear market.
It will look at the volume and volatility of SPY during these critical times in history. And the results are extremely interesting, so I encourage you to stay tuned!
Why does it matter?
Volatility generally refers to how quickly markets move and can signify a varying degree of risk. The more volatile = the more risk. We can see this pragmatically when we look at options. IV or implied volatility measures the degree of volatility inherent in a stock. Market makers, traders, hedge funds and financial institutions pay very close attention to IV levels during times of high volatility or key political, economic or organizational events. For example, earnings releases, major announcements, etc. can all cause the IV to sky rocket, because it is a time of great uncertainty and there is a heightened degree of risk.
So why is it helpful to determine the financial crises volatility vs volatility now?
Well, this is debatable, but for me, in my opinion, it is informative and reflective of the current socioeconomic conditions of the market. Is the market interpreting our current situation as similar or dissimilar to the financial crises? If it is similar, how? If it is dissimilar, how? But moreover, determine how far a stock is trading from its average price will tell us whether or not we are in a bear market. If a stock is trading BELOW its average, and experiencing negative growth, we would say that this is bearish and we are in a bear market. If it is trading at its expected growth, we would say that it’s a stable market. If it is trading BELOW its average and expected growth, then that is indicative of a bear market.
This is quite a powerful analyses to give us insight into how the market is interpreting our current circumstances, whether it is interpreting them with the same uncertainty as was present in 2007-2008 or if it is behaving differently owning to the different circumstances. Also, the 2007-2008 crises were a clear example of an unquestionable bear market.
How do we measure volatility?
Financial volatility is a difficult measure. Generally, volatility refers to the average amount a stock has differed from its mean over a specified period of time.
This is EXTREMELY important because, for this study, I obviously need to calculate volatility. And because I know volatility measures how far a stock deviates from its mean, it dictates to me the type of statistical test I need to apply to determine volatility.
In this case, I will need to calculate the z score of the stock. What a z score measures in statistics is the deviation from the mean. The z-score value expresses how many standard deviations from the mean a value is.
For this study, I will use the stocks high daily high value to calculate the z-score.
Volume: Then and Now
The chart below depicts the traded volume of SPY since its nascence in the 90s.
In this chart, we can see that SPY’s volume slowly increased from 1993 till around 2005, peaking in 2007 – 2008 only to slowly decline until roughly 2021, where it peaked again and then dramatically fell between 2020 and today. The peak of volume in 2008 can likely be explained by the huge amount of liquidations that happened across multiple financial institutions and investment firms. Otherwise, volume has, statistically speaking, maintained normalcy from 2009 until today, without any major peaks or tapers.
We can see how volume slowly increased over 2007 – 2008 in the chart below:
And the chart below shows volume from 2021 till currently
We can see some peaks in volume starting this year which correlate to the major sell offs we saw at the beginning of the year; however, not comparable to the 2007-2008 crises.
Volume conclusion:
We are not currently seeing the same, dramatic volume as we saw during the 2007-2008 financial crises. This is anecdotally explainable by the fact that the circumstances leading up to the mass influx of volume are completely different. We are not seeing mass collapses of financial institutions leading to liquidations of assets. What we are likely seeing here (there is no way to say this with absolute certainty), is some liquidation of assets from investors and institutions owning to the current economic uncertainty. But nothing comparable to what we have seen during financial and economic chaos. This I would interpret positively. It means we are not seeing massive liquidation of assets that signify an impending or occurring collapse.
Volatility:
The chart below shows the volatility from 2007 – 2008.
IN this chart, we can see that leading up to the collapse, stocks were trading roughly 1 standard deviation ABOVE their mean, indicating bullish sentiment and quite sizeable buying.
We then see, between the beginning of 2008 into June of 2008, stocks were flat. Trading at values roughly around their mean. After June 2008, stocks saw a dramatic decline and hard selling and ultimately ended up spending approximately just over 3 months trading below 3 standard deviations from their mean, indicating fast, rapid selling.
The chart below summarizes the volatility from 2021 – current
This chart is extremely interesting!
We see that stocks dropped roughly 2 standard deviations BELOW their mean at the start of 2021 (i.e. the COVID collapse), which slowly tapered off and then resulted in stocks trading roughly at 1 standard deviation from their mean between July 2021 and the start of December 2021.
In December 2021 we see stocks almost reach a trading area of + 2 standard deviations above their mean (i.e. SANTA RALLY!) only to see them return to trading roughly at their mean in January of 2022 and then resume trading 1 standard deviation above their mean until currently.
You may be asking, what is going on? Aren’t we selling off?
Yes! But!!!! As I have explained in a previous post titled “explaining bear markets mathematically”, SPY and the market as a whole underwent somewhat unnatural growth. We can see this so clearly in this chart. From July 2021 until the beginning of this year (January 2022), SPY was trading at + 1 standard deviation from its mean. That is almost 1 full year of the market trading ABOVE where it should have been trading. So, even though we are experiencing mass selling currently, we still have not brought the stock to BELOW its trading average.
Isn’t that insane?
Conclusion
So what can we say based on these results?
I will summarize the facts from this analysis:
• The current volume we are experiencing is less than the volume in 2007 – 2008. This indicates that the market is not liquidating to the extent that it was during the financial crisis. While there is still mass liquidation, it is not to the same extent as it was during the financial crises.
• While stocks have declined in value and have been selling off since the beginning of the year, the overall market still remains somewhat overbought and remains trading about 1 standard deviation over its mean.
• I would argue based on this data that we are NOT in a bear market currently, as the market is technically over-inflated and trading above its expected growth range. Not until the market reaches – 1 standard deviation from its average would I begin to stipulate that we are in a bear market, as that would be negative growth.
• The 2007-2008 financial crises were both fundamentally and pragmatically different than our current circumstances. The market is not behaving identically in any way.
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