by Denise Chisholm, Director of Quantitative Market Strategy, Fidelity Investments
Markets are built on uncertainty, but some weeks feel more uncertain than others. The S&P 500 officially entered correction territory, dropping 10% from its highs. Yet even before that threshold was crossed, we witnessed a cluster of rare and extreme market rotations – signals that have only happened a handful of times historically. Last week, I highlighted the sharp shift in sentiment, a move from optimism to pessimism not seen since the Gulf War. That wasn’t the only anomaly. Interest rates and oil prices fell at a rate seen less than 5% of the time. Implied correlations – an often-overlooked but important measure of market stress - spiked in a way seen just five times since 2011. And investors fled into defensive sectors at a pace typically associated with wars, crisis, and recessions.
While every extreme move feels unique and unparalleled, history can provide context because - despite the glaring differences -market patterns tend to repeat. There is an important relationship behind the surge in implied correlations (a measure of indiscriminate selling): the bigger the spike, the more likely the market is to be higher in the next 6 months. Our current move is rare, but even top decile spikes in history have preceded positive returns almost 90% of the time. In instances beyond that threshold, markets have been higher across the board. None of this guarantees an imminent bottom, but it’s important to note that quite often it has been a signal of opportunity..
The surge into defensive sectors – staples, healthcare, utilities, and telecommunication services – shares striking similarities to the spike in implied correlations. These sectors have underperformed significantly over the past few years. The sudden reversal we just saw might seem like the start of a new trend. But history suggests otherwise.
Once the market makes (what looks like to me) a panic-driven rush into defensive sectors, it has historically paid to take the other side. The quicker the rotation, the more likely defensive stocks were to underperform over the next 6 to 12 months. Could it be different this time? Surely. But history suggest that when extreme signals emerge, they often lead to familiar outcomes. The question isn’t just whether things have changed – its whether they’ve changed enough to break the patterns that have repeated time and again.
This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.
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