What Next?

Schwab's Liz Ann Sonders writes..

Regardless of the remedies proposed and tried, it’s becoming more and more likely we’re facing a global recession. As you know, that’s been our view. We’re seeing a collapse in global industrial demand as evidenced by oil, coal and steel declines yesterday. Here in the United States, a lot of economic news is being pushed to the back pages, but it’s grim nonetheless. First of course is the impact of the stock market correction: the 9% drop we saw yesterday wiped out $1.3 trillion in value for equities’ holders (twice the value of the failed rescue plan). August’s personal income and spending numbers were out yesterday and they showed real spending unchanged last month, weaker than expected. It now appears that third quarter consumption will fall at a 2% annualized rate, which would be the worst performance since the end of 1991. A lot of the pressure is coming from autos, but consumers are cutting back broadly. And of course, we have the monthly jobs report this Friday, which will capture the market’s attention given the recent acceleration in the deterioration of employment conditions.

When the market moves dramatically in a single day, the volatility index (VIX) gets a lot of attention. Yesterday saw a big move in the VIX. According to Bespoke Investment Group, the 34% move yesterday was the sixth largest ever on a percentage basis. Large moves in the VIX aren’t necessarily indicative of any future direction in the market. Following the 10 largest one-day percentage moves since 1990, the S&P 500’s performance in the following day, week, month and quarter is mixed.

While large one-day moves tell little about the future direction of the market, the S&P 500’s performance following a high absolute reading in the VIX, more specifically above 40, is more consistent. Yesterday, the VIX closed at 46.7, which is the highest level in the index’s history. Since 1990, there have been four other periods when the VIX closed above 40. Following each period, the S&P 500’s performance was mixed the following week, but over the following month and quarter, the S&P 500 had consistently positive returns.

But before getting too excited, let me make one final comment on yesterday’s stock market action. It’s very rare to see selling pressure this great when the market is diving to a fresh 52-week low. It has only happened once in history and that was the crash of 1987. Historically, when we’ve seen similar action, the precedent is for a short-term bounce followed by extreme volatility which has typically, though not always, led to a medium-term lower low.