2017's Stock Market Can't Get Stranger

July 28, 2017

What's been unusual about this year's market ascent is not how much stocks have risen. A gain of 12% for the SPDR S&P 500 ETF (SPY) through seven months of the year, while impressive, is well within historical norms.

Rather, it's been the consistency and uniformity of the rally that has caught everyone off guard. In the ETF world, an investor could almost throw a dart and come up with gains. Everything from mega-caps to large-caps to midcaps to small-caps is up. 

 

Ticker Fund YTD
Return
(%)
DIA SPDR Dow Jones Industrial Average ETF 11.5
SPY SPDR S&P 500 ETF 11.9
VO Vanguard Mid-Cap ETF 11.5
IWM iShares Russell 2000 ETF 7.2

 

Nor have investors had to deal with any kind of adversity. Despite the disarray in the Trump administration, there have only been a few days in which the market has sold off more than 1% this year, and the largest peak-to-trough correction was around 3.3%.

The CBOE Volatility Index (VIX) perfectly illustrates how unusual this year's market environment has been. In an astonishing move, the VIX, which measures the implied volatility on S&P 500 options, fell to a record-low of 8.84 earlier this week as investors gave up on hedging their portfolios against a sell-off.

In fact, betting against the VIX using inverse exchange-traded products has been the best ETF trade of the year, with gains of more than 100% for the VelocityShares Daily Inverse Short-Term ETN (XIV) and the ProShares Short VIX Short-Term Futures ETF (SVXY).

Corrections Are Common

In a year like this, it's easy to get lulled into a false sense of security. Especially for new investors, who have only seen the stock market steadily climb, it's important to understand that a correction―or more ―is as inevitable as the rising sun.

Since the bull market began back in 2009, there has been a pullback in the S&P 500 of around 10% or more in every year except one―2013.

 

That doesn't mean a correction is necessarily coming soon, but it does mean they occur more often than many investors realize.

 

Year Largest
Correction
(%)
2010 -17.1
2011 -21.6
2012 -10.9
2013 -7.5
2014 -9.8
2015 -12.5
2016 -12.2*
2017 -3.3

Data measures correction from peak-to-trough, including intraday values. *Correction took place between the end of 2015 and early 2016. Drop was even larger (14-15%) when measured from late-2015 values. 

 

Expect The Unexpected

Meanwhile, the VIX is almost certainly not going to remain at these record-low levels and will eventually rise to and exceed its long-term average of 19.5. On that day, the "picking up nickels in front of steamrollers” strategy of shorting volatility will be hammered.

Even more, at some point, the current bull market itself will end, ushering in a much steeper decline in the stock market exceeding 20%, 30% or more. It's easy to forget that the S&P 500 dropped more than 50% on two occasions between the years 2000 and 2009.

Zooming out further, it's also worth remembering that the longest economic expansion in U.S. history is 10 years, and we're more than eight years into the current one. Eventually, there will be a recession.

The point of these figures isn't to frighten, but to remind investors that the current stock market environment is an outlier rather than the norm. Expect stocks to sell off and volatility to return―at any moment.

A large part of investing is psychological, and expectations play a big role in determining whether someone can stay the course or whether they’ll succumb to bad, short-sighted decisions when the market takes a turn for the worse.

At the time of writing, the author held none of the securities mentioned. Contact Sumit Roy at [email protected].

 

Find your next ETF

Reset All