By Ryan Vlastelica
2017 was the quietest year for stocks since 1964, despite a host of headwinds
The U.S. stock market in 2017 was notable for two trends that were related, but separate: gains were pretty much consistent throughout the year, and so-called risk assets didn't see the kind of fluctuations they historically do.
The first trend had a few driving forces behind it, including improving economic data, growing corporate profits and the Republican Party's tax-reform package. All of that contributed to the market's upside momentum last year, helping stocks post their biggest annual gain since 2013 (http://www.marketwatch.com/story/these-are-all-the-records-stock-indexes-are-poised-to-hit-as-december-comes-to-a-close-2017-12-29).
The other trend, historically low volatility, has quietly unspooled beneath the surface of the major indexes, resulting in what Goldman Sachs considers to be "the defining characteristic of the U.S. equity market in 2017. It's a factor that set the S&P 500 up for a historic streak without even a mild pullback of 5% (http://www.marketwatch.com/story/heres-another-milestone-the-sp-500-could-surpass-this-month-2018-01-03).
Per Goldman's analysis, the S&P 500 had a realized volatility score of 7 in the year, which is "ranked in the first percentile since 1930." It added that "the risk-adjusted price return of 2.9 ranked in the 97th percentile relative to history."
According to the WSJ Market Data Group, the absolute daily percentage change for the Dow Jones Industrial Average was 0.31% in 2017. It was 0.3% for the S&P, and in both instances, that represents the smallest absolute daily percentage since 1964. For the Nasdaq Composite Index , the absolute daily percentage change was 0.44%, the smallest since 1989. The average observed one-month volatility in the S&P 500 was lower than any other year since 1970 in 2017.
Of the 56 lowest closing levels in the history of the Cboe Volatility Index (since 1990), 47 of them occurred in 2017. The so-called "fear index" also notched two all-time closing lows. The VIX is currently trading at 8.95, or less than half its long-term average of 20. Wednesday marks only the fifth time in history (http://www.marketwatch.com/story/wall-street-fear-gauge-tumbles-threatens-to-notch-fresh-record-low-2018-01-03) that the Vix has dropped below 9, according to FactSet data. If the Vix ends at current levels, that will mark the lowest close in its history.
What accounted for this, in a year when U.S. stock valuations were widely seen as elevated (http://www.marketwatch.com/story/this-1-chart-shows-the-us-stock-market-is-the-most-expensive-in-the-world-2017-12-28) and there were numerous instances of political instability--the kind of macroeconomic shock that can easily result in short-term bouts of weakness? It may sound counter-intuitive, but one of the primary reasons why broad-market volatility has been so low is because stock-specific volatility hasn't been.
Correlations, or the degree to which two different securities move in tandem with each other, have dropped sharply of late. For the S&P 500, correlations are at 0.1, according to data from S&P Dow Jones Indices, well below its median read, which is close to 0.35. A reading of zero would represent no correlation whatsoever, while a read of 1.0 would represent perfect correlation (a reading of negative 1 would mean perfect inverse correlation).
"Record low correlations accompanied the relative lack of market swings, and indeed may be seen as a causal factor," S&P wrote in a research report. "Markedly different reactions to the year's major events created stronger diversification effects, dampening volatility in the benchmarks."
Read more about correlations:Beneath a calm surface, the stock market is undergoing a major change (http://www.marketwatch.com/story/beneath-a-calm-surface-the-stock-market-is-undergoing-a-major-change-2017-11-15)
Volatility is elevated in periods of high correlations because stocks move in the same direction at the same time, and such broad-based moves are reflected in the major indexes.
"When sectors move more independently, actual volatility will drop (everything else equal) as marginal winners offset losers," wrote Nicholas Colas, co-founder of DataTrek Research, who called correlations the "secret sauce" in equity-market volatility.
The VIX "is going to have trouble rising in value as long as correlations remain low," he said.
-Ryan Vlastelica; 415-439-6400; AskNewswires@dowjones.com
(END) Dow Jones Newswires