FINANCIAL SENSE: HOW RARE IS THE CURRENT MARKET?Submitted by Raleigh, NC Financial Advisor | Golden Years Advisors on January 25th, 2018
Wow! What a year markets had in 2017 and they are off to a strong start in 2018 as well. 2017 was the first time in the history of the S&P 500 that the index had positive monthly performance every month in a calendar year. Since the November presidential election in 2016, the S&P 500 has recorded 14 consecutive monthly gains and is up over 6% year-to-date as I am writing this blog. Obviously, this is historic performance, but how RARE is the current market environment?
If there is one thing that stock markets are known for it is volatility and change, but markets have been extremely quiet since the Presidential election. Historically, the S&P 500 has about 75% of its trading days with gains / losses between -1 to +1 and another 10% - 11% of its trading days with losses of either -1% to -3% or gains of +1% to +3% (see chart below). Amazingly, 95%+ of all trading days were tightly clustered between -1% losses and +1% gains, and less than 2% of all trading days had losses of =1% to 3% or gains of +1% to 3%. It has been a very calm market indeed!
Source: NASDAQ Dorsey Wright’s “2018 Market Outlook”.
When markets are THIS calm, many investors are waiting for the volatility to increase – it’s only natural for the pendulum to swing back to the long term “average” volatility. We too, expect volatility to return to more “normal” levels but we don’t believe that we need to be fearful that the next bear market is about to devour the markets.
Let’s be candid: our current bull market WILL eventually end at some point and there is always a chance that tomorrow, next week, next month IS that time. But this is always true and always possible, just as none of us know when we will take our last breath. But as we have discussed before, only 1 (rich valuations) of the 5 so-called “bear pawprints” (recession, aggressive Fed tightening, commodity shock, extreme valuations, and war / geopolitical “surprises”) is flashing a warning sign.
High valuations always precede any “bear” market for stocks, but markets have survived at “rich valuations” (e.g. 1 – 2 standard deviations higher than their long-term average) for extended periods. Many “experts” have argued that our soon to be 9-year old “bull” market (March 9, 2018 will be the 9th anniversary) has been “pricey” with rich valuations for several years now.
So even though we know that volatility WILL INCREASE and stock price valuations WILL EVENTUALLY RETURN to long term “averages” and past performance does not guarantee future results, what can history teach us about similar environments? Consider the following chart where blue dots indicate the maximum market decline during a calendar year and the gold bars show the year-end return of the S&P 500 during that same year. Please note that since 1979 there has only been 1 other time where the market volatility was near as calm as 2017 (see the red boxes below). Once again, rare times indeed.
Source: NASDAQ Dorsey Wright’s “2018 Market Update”
To re-cap: we are not in the business of predicting the markets, but we do take comfort that although volatility is sure to rise, low volatility in the prior year is a poor predictor of “bear” markets.
Stay tuned for more thoughts on overbought markets.