If the US stock market made a noise it would sound like crickets right now. As I write this piece in early May, the S&P 500 index has not moved up or down by more than 0.2% for the last nine trading days in a row. The last time the market experienced such a long streak of flat trading days was in 1964! In fact, there have only been three trading days so far in 2017 in which the market moved 1% or more, and all three were in the month of March. Overall market volatility, the standard unit of investment ‘risk’, has fallen below 10% in the US compared to its long run average of around 16%. Market volatility has not been this low since 1993. As evidence-based investors, can we draw any conclusions from other periods of suppressed volatility?
First, it’s important to know that volatility is somewhat cyclical and that long periods of both high and low volatility are evident in the historical data. Volatility was similarly low for three years from 1993-1995, right before the beginning of the powerful late-1990’s bull market. It was also very low again from early 2005 to the middle of 2007, a few months before the great financial crisis. Low volatility preceded very high returns in the first case and very low returns in the second. Just by observing those two recent examples, it appears that low volatility by itself does not tell us much about subsequent stock market returns.
Secondly, we should probably use this opportunity to remind ourselves that stocks can and do go down sometimes! On average, according to InvesTech Research, the S&P 500 index has experienced a 5% drawdown about every 7 months, and a 10% decline every 26 months since 1932. (Larger declines of 20% or more occur about every 3.8 years.) And since 1980, investors have suffered an intra-year decline of 5% or greater in every calendar year, except 1995. Despite suffering several of these 5% ‘corrections’, the US stock market is up more than 200% since March of 2009.
Finally, we should also remember that markets do not follow a predictable schedule. From the above chart, we can see that the last major correction ended in February of 2016, nearly 15 months ago. While that is 8 months longer than the ‘average’ period without such a correction, we still can’t say with any confidence exactly when the next 5% correction might happen. But unless risk has been permanently wrested from financial markets, we can be sure that stocks will experience a drawdown again in the not-too-distant future.
As long-term investors, we know that volatility is the price we pay for positive, inflation-beating returns. And given the historical data, we shouldn’t be too surprised when the next correction does arrive. At the same time, after such a long period of relative stability, the next correction may feel particularly jarring. It may be helpful to recall that corrections provide opportunities as well, and that a well-designed portfolio is engineered to anticipate, and even benefit from, periodic corrections that allow for regular, disciplined rebalancing. It’s all part of the plan.