Putting the stock market's low volatility into perspective


With 2017 half-over, volatility has been notably absent from the U.S. stock market year-to-date. There are a few measures that demonstrate just how little volatility there is in the stock market right now:

  1. VIX has been near all-time lows for many months.
  2. The S&P 500’s maximum intra-year drawdown is 2.8%.
  3. The S&P has only had 2 1% down days in 2017 so far.

We’re not a huge fan of VIX because VIX’s history only goes back to 1990.
The S&P’s maximum drawdown in the first half of 2017 was a meager 2.8%. Only 1995 witnessed a smaller drawdown in the first half of the year – 2.5%.

The S&P has only fallen more than 1% twice year-to-date in 2017. This is another signal of low volatility.

Based on this measure, 1954, 1958, 1961, 1963, 1964, and 1995 were all low volatility years (years with 5 or fewer 1% down days).
Let’s see what happens to the S&P after it experiences a low volatility year.

1954

The S&P 500 went up in very steadily in 1954. The next significant correction began more than 1.5 years later in the summer of 1956.

1958

Climbing out of the 1956-1957 significant correction, the S&P rallied steadily in 1958. Although the S&P consolidated from mid-1959 to late-1960, it did not make a significant correction (as defined by our medium-long term model). The next significant correction began 2 years later in December 1961!

1961

After the stock market rallied steadily in 1961, it made a massive correction in 1962. This was because the U.S. economy tanked in 1962. This case is not applicable to the present because the U.S. economy is growing decently right now.

1963-1964

The stock market experienced 2 years of low-volatility growth from 1963-1964. The next significant correction began 1 year later in early 1966.

1995

As you probably know, the S&P’s rally in 1995 was exceptionally fierce by all measures. The S&P’s next significant correction began 2.5 years later in mid-1998!

Bottom line

These cases all point to the same conclusion. When stock market volatility is low, the S&P is unlikely to make a significant correction any time soon (i.e. next year). There’s a logical reason for this. When the stock market’s bullish momentum is strong, the stock market will not crater when the next correction begins. With bullish memories fresh in their minds, there will be investors who “buy the dip” and push the S&P to new highs.
*1962 was an exception because the U.S. economy cratered. The U.S. economy cratered because credit evaporated as the U.S. prepared for the Vietnam war. The U.S. economy is perfectly fine today and there is no risk of a major U.S.-led war.
This study coincides with our medium-long term model, which does not see a significant correction in the foreseeable future.
This does not mean that the S&P cannot make a “small correction” in the next few months. The S&P is now in the 96th percentile of history’s “small rallies”.
*It has been 257 trading days since the last small correction. Only 3 “small rallies” have lasted longer.

  1. 335 trading days (October 5, 1992 – January 31, 1994).
  2. 297 trading days (December 9, 1994 – February 13, 1996).
  3. 284 trading days (November 16, 1988 – January 3, 1990).

With this current “small rally” so aged, the S&P can make a small correction at any time in the next few months.
 

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