Markets enjoying period of calm not seen in decades

With little volatility in stocks this year, analysts wondering how long it can last

This year’s run to a record for the stock market has been one of the calmest in decades. Just don’t get too comfortable.

Only twice this year have investors had to deal with a one-percent drop for the Standard & Poor’s 500 index in a day. That’s far fewer than typical.

The last time stocks sailed through such an uneventful first seven months was in 1972. Broaden the scope to include when the S&P 500 fell or rose by one per cent in a day, and this could be the least volatile year for stocks since 1964, if the current pace holds.

But as central banks start to wean markets off the stimulus they’ve injected into the global economy, many money managers say they’re preparing for a bumpier ride ahead.

For now, markets have been so calm that the biggest loss for the S&P 500 last week was just 0.2 per cent. Compare that to the whiplash investors felt during the summer of 2011, when the S&P 500 swung by more than four per cent each day during one four-day stretch.

Investors fortunate enough to be in the market have enjoyed all the upside of owning stocks with almost none of the traditional downside. Stocks are supposed to be volatile, and investors have long accepted that having to stomach big swings in price is one of the costs of owning them. But the largest stock fund by assets, Vanguard’s Total Stock Market Index fund, has already returned 11.2 per cent in 2017 with only a few big down days.

“At the surface, it is surprising” how calm stocks have been, says Greg Davis, Vanguard’s chief investment officer. “But it’s not surprising if you think about a world where central banks have been unbelievably accommodative. I think investors still think central banks will step in if there’s any stress in the financial markets.”

The Federal Reserve and other central banks around the world have slashed interest rates and thrown trillions of dollars of stimulus at the global economy since the 2008 financial crisis. Not only that, profits for S&P 500 companies started growing again late last year, inflation remains low and economies around the world finally seem to be in a synchronized move higher.

But the Fed is now slowly moving in the opposite direction: It has raised short-term rates modestly three times in the last year. The central bank also expects to begin paring its vast portfolio of bond investments “relatively soon.” Investors on both sides of the Atlantic, meanwhile, are handicapping how long it will be before the European Central Bank pulls back on its bond-buying program.

That could force a return to more typical levels of volatility. Over the last half century, the S&P 500 has had a median 26 days where it fell by at least one per cent during a year. The worry is that the stock market may not only get back to that level but overshoot it.

If central banks aren’t the trigger to reawaken market volatility, analysts say it could be anything that comes as a big surprise to investors, such as a natural disaster, international conflict or unexpected drop in corporate profits.

In a recent survey of investment managers at about 100 firms by Northern Trust Asset Management, 63 per cent called the market’s lack of volatility a warning sign that may lead to a sell-off for stocks. That’s even though half the respondents expect corporate profit growth to increase, and most forecast stable economic growth, conditions that are typically favourable for the stock market.

Some investors would actually welcome a return to topsy-turvy markets.

It could lead to higher revenue for Wall Street banks, as nervous clients make more trades. And it could offer bargain-hunting opportunities for mutual funds run by stock pickers, who have been broadly falling short of index funds’ performance.