Published December 22, 2017
2017 feels like an extraordinarily good year for the stock market. While it is above average, the market had a substantially better year only four years ago, and another 20%+ gain four years prior to that. What differentiates this year is the extreme calm that investors felt all year long. For only the second time in the past 35+ years, the WORST decline the stock market encountered was a measly -3%. Many stocks move that much in a day.
The chart below highlights this rare lack of decline. The bars provide the market return for the year. The dots below show the worst decline for the year. You can see that declines around -10%, give or take a few points, is the norm for the market. Declines of more than -10% are quite common.
Consistent with the low level of decline is a record low level of market volatility. The VIX index measures investor angst, expressed as a desire for buying “insurance” in the form of options. The bars in the chart below represent one quarter (three months) in time. The horizontal line is drawn at 11 – a level which historically has been a “support” level for this index as the chart clearly shows. However, last quarter for the first time, the index closed the quarter below this level. It looks set to repeat that rare feat again this quarter.
A fun parlor game (do people play those anymore?) is to speculate what will cause volatility to return to the market. While investors currently feel no pain and see no storm clouds on the horizon, we know that the calm does not last very long. This exceptional period of market happiness will come to an end. What will cause it to end? Some unforeseen financial problem? A geopolitical event? Or merely the turn of the page into a new year and a bout of profit-taking?
2017 has been incredibly benign. History says 2018 will not be a repeat of that calm.
Tax reform continued to boost the stock market this week with the market indexes adding +0.5% in Monday’s trading on news of further tax reform holdout votes swinging in favor of the tax package. The package now assured of passage. However, Tuesday saw investors taking back some of those gains as a downgrade of Apple (AAPL) hit that market-leading stock while interest rates shot upward. The tax reform bill generates at least two possible scenarios which support higher interest rates:
- a quickening of economic growth which in turn could ramp inflation, and/or
- a widening of the federal budget deficit which would require increased issuance of government bonds to provide financing.
Those two scenarios combined to send interest rates sharply higher Tuesday while the stock market dipped -0.3%. 2-year U.S. Treasury yields are approaching 2.0% for the first time since the financial crisis. They were at 1.3% as recently as September. So it has been an exceptionally quick and sharp move higher. Energy shares rallied Wednesday on higher oil prices while interest rates continued their ascent. Stocks held flat overall on the day. Shares continued their positive bias Thursday holding to a +0.2% move with energy stocks continuing to move higher. Friday’s pre-Christmas trading was listless as expected with markets unchanged. The fireworks occurred in the bitcoin arena with that high-flying asset plunging after its heady runup earlier in the month and throughout 2017.
The S&P 500 (SPY) lifted +0.38% as the tax reform package came together. It was the index’s fifth straight winning week. We have to go all the way back to July to find any notable pressure on the index. It’s been an amazing run ever since, an 18 week bull charge. The Nasdaq 100 (QQQ) held flat with a +0.03% return on the week. Small-cap stocks (IWM), seen as significant beneficiaries of the tax reform, led with a +1.01% weekly gain.
Warm wishes and until next week.