What could disturb unprecedented calm in markets?

Matthew F. Beaudry

Matthew F. Beaudry
Senior Investment Director , 11/9/2017


  • What’s remarkable about 2017 is not multiple rising asset classes, but low stock market volatility.
  • Historically, low market volatility has not signaled greater risk of an impending market downturn.
  • Underpinning the markets are global economic growth and rising corporate earnings – factors that are more important than volatility levels.

A new U.S. president, geopolitical tensions with Russia, Iran, and North Korea, and devastating hurricanes in the Gulf of Mexico — any of these factors might have seemed disruptive, but they have done little to interrupt the calm in capital markets this year. Stock indices in the U.S. are at record highs, and gains have been widespread. Domestic, international, large-cap, and small-cap stocks, as well as growth and value strategies, have appreciated this year, as have fixed-income sectors. Assets are rising on the strength of an accelerating global macroeconomic expansion.

Multiple asset classes have positive returns in 2017

A calm rally

How common is it to make money in every asset class? It’s unusual, but not unprecedented — 1995 and 1996 saw similar trends.

However, what is unprecedented in this market rally is the extremely low level of volatility. The Chicago Board Options Exchange Volatility Index (VIX) is a forward-looking index that measures the implied volatility of the S&P 500 Index. Between 1990, when the VIX was created, and 2016, the index finished under 10 only nine times. That compares with a record 35 times so far in 2017.

The volatility index has set a record for calm days

Low volatility alone does not signal risk for stocks

A low VIX does not imply danger for the equity markets. When the VIX is below its historical average, stocks have performed well regardless of whether the volatility index rose or fell. A low VIX has been correlated with higher price-to-earnings ratios (PEs). However, investors should not be concerned about high multiples because when volatility is low, equity markets are much less likely to decline.

Goldilocks zone in the United States

U.S. markets are enjoying a rare “Goldilocks” scenario of high growth and low inflation. Investors remain positive on growth and corporate earnings prospects in the United States and globally. The consensus is for strong earnings-per-share (EPS) growth for companies listed on the S&P 500 in 2017 and 2018. The Trump Administration is pushing to enact long-awaited tax cuts next year.

We can trace the beginnings of this year’s market appreciation to the summer of 2016. Global and domestic Purchasing Managers’ Indices (PMIs) — a measure of things such as new orders, inventory, production, and employment — reversed trend and began to accelerate in the third quarter of 2016. The Composite PMI is a measure of economic health and often indicates future economic growth. An uptick in earnings expectations globally also supported the markets.

Focus on global growth and earnings

How is it possible that with a volatile new U.S. president, markets achieved an unprecedented calm? How could the geopolitical tensions with Russia and Iran, the saber-rattling with North Korea, the Las Vegas shooting tragedy, forest fires in California, and the devastating hurricanes in the Gulf of Mexico have done little to interrupt the calm in the capital markets?

Ultimately, we believe the answer lies in continued global macroeconomic expansion and accelerating earnings expectations. If those two factors continue to be favorable, the United States and the rest of the world can remain in expansion mode, and the secular bull market could continue.

At some point ahead, there will be mean reversion and higher volatility in the market. However, history would suggest, with the strong fundamental environment and no economic recession on the horizon, low volatility could continue in the short term.

You can see our related research on this topic in our previous Perspectives blog posts, including our most recent viewpoint, “Why a meaningful near-term market correction is unlikely.”

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