Second Big Gap Down In Three Days

Futures are indicated to gap down heavily again this morning, with the S&P 500 currently looking at an open of -1.8%.

Barring a recovery before the open, this would be the second gap open of -1.5% or more in the past three sessions, an event that last occurred nearly five years ago.

The table below shows every time since the inception of the futures in 1982 when there was a second gap of -1.5% or more within three trading days.

Returns going forward were highly positive but also volatile. When stocks rallied, they rallied big; when they declined they declined big. This isn't a surprise, but six months and one year later, returns were extremely positive, double an average return, even including the negatives from 2008 which made up the bulk of the instances.

What's unusual about our current occurrence is that it is happening so close to a recent high. Today's open is indicated to be about 7.5% from the highest close of the past year. This would be the smallest the S&P had ever declined from a peak before suffering such gaps.

The only other instance when the S&P was within 10% of a 52-week high was October 1997, after which the futures rallied almost right from the get-go.

The only others when within 15% of a 52-week high were in May 2010, after which there was some back-and-forth but again mostly limited downside in the weeks ahead.

There were only two others that occurred in January (2008 and 2009). Even during the teeth of the bear market, these gaps led to choppy rebounds. Granted, that was from what had been sell-offs much heavier than what we've seen this time.

Opening gaps like this are disconcerting, especially given some of the concerns we've outlined recently in the Daily Reports, but if we accept that opening prices are mostly "dumb money", reactionary trading, then we should interpret these gaps as temporary and likely to lead to higher returns in the weeks ahead.