An Increase In A False Sense of Safety in the Stock Market

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The NASDAQ index finally topped its previous closing record set on March 10, 2000. It took 15 long years and the S&P 500 has also been setting new highs every couple of weeks. The question for investors and media pundits is, “has the easy money been made?” As a professional money manager, I am not sure there is such a thing as “easy money” but this question rings a familiar tone. As long as the majority thinks the markets are in trouble, the better the markets tend to do!

As Morgan Housel recently pointed out, in 2009, Barron’s published an article titled, “The easy money has been made.” Interestingly enough that was followed up in 2010 by an identical headline in Morningstar. The same title was used in 2011 by Marketwatch, in 2012 by The Street, and in 2013 Morningstar re-purposed the headline before Barron’s used it again in 2014 and recently CNBC ran a story with it in March of this year!  Along the way, the market reached new highs with below normal volatility. The S&P 500 is currently on a 74-month streak without a 10% correction. The average length of a bull market is 54 months. The scary headlines might generate unease among investors, but you can only say the sky is falling so many times before ears become deaf to market noise.

Today’s markets are what we call “long in the tooth” for sure. There has been a recent change in leadership from the smaller companies in the S&P 500 to the larger ones.  Typically this trend signifies that investors’ risk appetites are waning. That doesn’t mean the end of the world or another 2008 Armageddon but it does imply we should expect more future volatility.

Another noticeable change is that foreign markets are outpacing the U.S. market for the first time in more than three years. We must be alert to clues and consider the broad evidence before making investment decisions.

Complacency is the art of being satisfied and without worry. Summing up the feelings of many equity savers today, “complacent” is an apt description. Over the last three years, the market has seen very little volatility while continuing to rise in value. This relationship of reduced market volatility compared to market performance in a three-year period is at the highest correlation since 1900 according to a study done by James Paulsen, Ph.D. of Wells Capital Management. Essentially, this analysis can be interpreted as giving a sense of false sense of safety to investors. The obvious concern should be what happens if volatility returns?

Humans are creatures of expectations. They expect bonds to be less volatile than stocks because that is what they have been told, but such conventional wisdom has proven anything but true this year. Investors expect the market to behave as it has in the recent past – straight up with little volatility. The reality is an average market year has a correction from peak to trough of more than 10% in most years. Volatility is almost nonexistent and investors seem to be whistling “Zip-a-Dee-Doo-Dah.” Risk may be resting, but it lurks in the water.  Be careful out there.

 

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.[/vc_column_text][/vc_column][/vc_row][vc_row][vc_column offset=”vc_hidden-lg vc_hidden-md vc_hidden-sm”][vc_widget_sidebar sidebar_id=”sidebar-main”][/vc_column][/vc_row]

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