When historians look back on the 2017 stock market, it will be weeks like this that they remember. Three up days, two down, volatility nowhere in sight, and a wire-to-wire gain of less than 1 percent.
According to Morgan Stanley, all that’s about to change.
Not that the firm’s chief U.S. equity strategist, Mike Wilson, is one of those people who goes around saying this year’s dearth of equity volatility is some giant mystery. Growth has been steady, he says, corporate profits predictable, and the Federal Reserve telegraphed its intentions to a T.
Stocks were calm because the economy was calm.
“And those are the things that are exactly going to change in 2018,” Wilson said during an interview with Bloomberg TV in New York. “We’re going to get more dispersion in earnings estimates, we’re going to get more dispersion in economic data, not quite as synchronous, we’re going to get the Fed tightening policy. We should expect more volatility.”
For now, U.S. shares are setting records for tranquility. The S&P 500 has gone 68 sessions without rising or falling 1 percent, the longest stretch since 1995. At one point it went 51 days without a 0.5 percent fall, the longest since 1965. Using a risk-adjusted measure called the Sharpe ratio, returns relative to volatility in 2017 are the third-best in half a century.
The Cboe Volatility Index has held below 10 about 20 percent of the time this year as the S&P 500 hit a record once every four days. A steady run-up in prices that came with a breakdown in stock correlations and few economic disappointments pushed anxiety measures like the VIX to heretofore unseen lows.
In the five days through Friday, the S&P 500 climbed 0.9 percent to 2,675.81 in its fourth straight weekly advance. The Dow Jones Industrial Average rose 323 points to 24,651.74 during the period. The Nasdaq Composite Index added 1.4 percent to 6,936.58.
To Wilson, next year’s macro environment is certain to be less benign, as central banks move toward less market-friendly policies. The U.S. tax overhaul will probably make it harder for U.S. firms to issue reliable earnings guidance, feeding equity turbulence.
“Earnings are going to go up, but let’s not forget, companies haven’t guided yet for 2018,” Wilson said. “It’s not clear that they’re going to give us what people are expecting.” New tax legislation “creates more dispersion in earnings estimates than I think people are expecting.”
So far this year corporate profits have evinced a remarkable predictability. Four days before Election Day, analysts tracked by Bloomberg predicted companies in the S&P 500 would earn $131.30 a share for the full year. The estimate is $128.50 now — one of the smallest variations in the last five years.
Wilson’s warnings may be of interest to traders who are betting on a lasting peace, including owners of exchange-traded funds and notes that go up when the VIX goes down. With $2.4 billion in assets, short volatility securities have amassed the most cash on record, according to data compiled by Bloomberg last month.
AllianceBernstein’s Vadim Zlotnikov echoes Wilson in forecasting that days of calm are numbered as the era of easy money draws to a close and uncertainty about global growth lingers. He recommends shorting a basket of the most crowded stocks and going long the companies with the most short interest.
“All you need is one Fed statement that says we continue to see an increase in wages, we continue to see an increase in employment and inflation in some of the regions,” Chris Bertelsen, chief investment officer at Sarasota, Florida-based Aviance Capital Management, said by phone. “And then at the end of a couple weeks you’re going to say, ‘Oh my gosh, what happened? The Nasdaq is 5 or 6 percent off.”’