Another Bearish SPX Signal Sounding

SPX returns are typically bearish when in current choppiness range

The Choppiness Index, an oscillator index used to measure how the market is trending (regardless of direction) or going sideways, is relatively new to me. It was created by Australian commodity trader E.W. Driess, and today we will analyze how it works on the S&P 500 Index (SPX).

Due to the last few months of coronavirus turmoil, it was lost on me that the S&P 500 has chopped around in recent weeks. As a result, the Choppiness Index has spiked. While the indicator tells us how the market is behaving, I'm going to explore what, if anything, it means going forward. The analysis below shows how the S&P 500 has performed based on specific levels of the Choppiness Index.

What Choppiness Index Spikes Mean

Driess considered an index level of 62 to be a benchmark for a choppy market. The index recently spiked to this level, so now we can see how the market has historically performed when this happens.

For this study, I went back to 1980 -- the year we started getting consistent daily high and low values on the S&P 500, which are needed to calculate the Choppiness Index. I found that the Choppiness index moved above 62 just a couple of weeks ago on May 13, the first time in at least six months. The table below summarizes the market returns after these occurrences.

The 62 level tells us that the index has chopped around recently (the index considers the last 14 trading days), but it does not seem to tell us much about the future. Looking at the average return and percent positive after the signals, they are not too different from the typical long-term returns. The main difference, in fact, is in the standard deviation of returns. The index spike, in the 15 signals since 1980, has tended to lead to less volatility as measured by the standard deviation of the returns.

Putting the Choppiness Index into Brackets

There is another way to look at it, though. Instead of focusing on breaking a certain level, I created brackets for the Choppiness Index level and simply calculated the one-month forward returns based on those brackets. The summary of the returns are in the table below.

The data suggests the broad stock market will likely struggle in the short-term. When the 10-day average of the Choppiness Index is above 55 (the current level is 55.6), the S&P 500 averages a 0.21% return over the next month of trading. That's the worst performing bracket. Otherwise, the S&P 500 averages a one-month gain of anywhere between 0.73% and 1.13%. Looking at the percentage of positive returns, the four brackets where the Choppiness Index is below 55 are all very similar: showing about 63%-65% of the returns positive. Once the indicator gets above 55, the percent positive drops to 57.5%.

Based on the analysis above, the 62-level of the Choppiness Index for the S&P 500 Index doesn't mean too much for stocks going forward. The 55-level, however, on the ten-day average of the Choppiness Index, tends to lead to returns that underperform normal market returns.