Fast V-bottom could mean SPX problems

However, the Nasdaq sees much more promising results after V-bottoms

The S&P 500 Index (SPX) is within striking distance of new all-time highs. If the index hits a new record soon, it will complete the V-bottom. It's obvious where the V-bottom gets its name – the sharp decline and quick recovery resemble a V on the charts.

This week I'll be looking at previous V-bottoms for the SPX to see how it typically performs in the future. The Nasdaq Composite (IXIC) has pulled back even lower than the SPX, but it's not as close to completing the V-bottom. Still, I'll be going over those numbers as well in anticipation of it doing so.

S&P 500 V-Bottoms

Since 1950, I have found times when the SPX hit an all-time high, fell at least 9%, and then hit all-time highs again. This happened 37 more times. The table below summarizes the returns following these signals.

Returns have been declining in the short term, with two-week and one-month returns below typical returns (see second table). However, longer-term returns are closer to typical market returns.

This recent V-bottom for the SPX was particularly quick, as the recent all-time high was only made a little over a month ago. I thought a 9% drop and a new high in a short period of time might be something completely different than one that happens over a longer period of time, so I separated the V-bottoms where the high, low and new high occurred within three months. There were 10 occurrences, the subsequent returns are summarized below.

These quick V-bottoms do not bode well for stock prices in the future. Not only have short-term returns been declining, but long-term returns have also fallen short of expectations. A full year after these quick V-bottoms, the SPX averaged a 3.1% return, with 50% of those returns being positive. The index typically averaged a 9.1% return, with 74% of the returns being positive over a 12-month period.

What about the Nasdaq?

We have IXIC data going back to 1971. The index's most recent decline was just over 15%, but it's still about 5% below its all-time high. With that in mind, let's look at returns after completing a V-bottom. Specifically, I looked at 15% declines and new highs within a year.

This has happened on eight occasions and the returns are much more promising than what we have seen on the SPX. These were buying opportunities, with the IXIC averaging a 12% gain over the next six months after these V-bottoms were completed, with all eight returns being positive.

Since 1978 (the year of the first signal), the index has averaged a 6.9% return over a six-month period, with 71% of the returns being positive. A year after these V-bottoms, the IXIC has gained an average of 25%, with seven of eight returns being positive. The typical 12-month return for the index has been around 14%. Hopefully, going forward, equity returns will be more like these IXIC returns and less like the SPX returns mentioned above.