Big two-day selloffs – What history suggests comes next

Key Takeaway

Big two-day market selloffs are often followed by significant swings in “both” directions over the following weeks. Short-term market returns tend to be mixed, though the probability of markets being higher increases as the time horizon expands.

Big picture

The S&P 500 just had one of its worst two-day declines in history, with a fall of 10.5%. Other market shock periods in the top 10 include the 1987 crash, 2008 Global Financial Crisis, and the 2020 pandemic.

Following previous sharp two-day selloffs, we have these observations:

• Volatility clusters: Big down days don’t typically occur in isolation. History shows that several of the S&P 500’s largest two-day declines were followed by some of the biggest two-day increases over the next 30 days (but also more down days).
• Mixed short-term returns: The likelihood of the stock market being up over the next few months following big two-day selloffs is mixed, and, in some cases, particularly in the fall of 2008, there was still a decent amount of downside. See table on next page.
• As the investment time horizon expanded to one or two years out, the probability of the markets being higher increased. This is a starting point, as history is only a guide.

More broadly, with heightened uncertainty around tariffs, the chances of a recession are rising. Our head of economics currently places that probability at 50%, with that likelihood rising the longer the higher tariff levels are maintained.

• Historically the median S&P 500 decline around recessions is 24% (29% average decline) versus the current pullback of 17% since late February.
• Said another way, the market appears to be pricing in roughly a 60% to 70% chance of recession.

The glass half empty view is the market has further downside potential if a recession materializes, and this could be a worse than the “typical” recession.

The glass half full view is the market is already pricing in a decent amount of the recession risk relative to the complacency at the February highs. Also, once markets find their low during a recession, the snapback tends to be sharp.

From a technical perspective, based on Sunday night indications, the S&P 500 is nearing a 50% retracement of the 2022 to 2025 bull market, which overlaps with the previous peak in 2021. This will be looked to as a potential near-term support level.

Bottom line

Our key message since late February remains that investors should be more neutral and less on offense relative to recent years given a more mixed risk/reward backdrop.

This view remains intact, though after the sharp market selloff, our work suggests this is not the time to become more negative, at least not in the short term.

History supports the notion that the near-term path forward will remain bumpy. Indeed, the data suggests during periods of heightened uncertainty, investors tend to extrapolate new information, often leading to large swings in both directions.

There could certainly be further near-term downside. Yet, in the sea of red, investors should not lose sight that when looking out over the next few years, history also strongly indicates a high probability that stocks will be higher from current levels.

Markets are now at least better discounting some of the uncertainty, and the bar for positive surprises has been reset lower. Thus, there is a risk of further market downside, but also a little bit of good news could go a long way.