For buy and hold investors, remaining long the S&P 500, purely based on the price action, has not been too hard of a trade in the last two years, the peak to trough draw-downs have become narrower and narrower, on the surface signifying less jitters.
The four year chart below shows the decreasing depths of the sell-offs, after the fairly extreme volatility in 2010 related to the course of the Federal Reserve’s commitment to quantitative easing (almost a 17% decline from the highs to the eventual lows) and then in 2011 the European debt crisis that saw the SPX drop more than 21% from the highs.
2012 saw some excitement mid-year as European fears re-surfaced and Washington dysfunction started to take center-stage in an election year. But the peak to trough declines continued to contract with an almost 11% decline in the spring and then a 9% peak to tough decline into the November elections. Last year was the year that might have hibernated the bears permanently with a mere 7.5% decline from the then highs in May, adequately labeled the “Taper Tantrum” as the Fed floated the trial balloon of reducing the pace of their quantitative easing program.
In hindsight, if you tuned out the fear, every dip was a great buy, though hindsight capital is always the easiest money.
As for complacency, as one would expect, the VIX has ground back down to 4 year lows with the pops in volatility getting smaller and smaller over that period.
Those waiting for a pullback must be asking how long could this actually go on for? Your answer is as good as mine, but make no mistake about it the inverse relationship between the price of stocks and the volatility of the underling CONTINUES to stretch, which only suggests that there is a too much complacency among equity investors. Could this overshoot all logical expectations? Of course. The 10 year chart below of the SPX vs the VIX should suggest a bit of a reversion at some point soon though.
Now let’s introduce one kind of important factor that is likely the one thing to cause more of the same or a mighty little flare up, interest rates. The same chart above with the yield of the 10 year Treasury (in green below) shows NO negative impact on the price of equities, despite the move from 1.5% to 3% just last week, while equity volatility continues to grind lower.
Rising rates have hurt certain asset classes mind you (like emerging market equities or commodities), just not U.S. stocks. Goldman Sachs research actually put an underweight on U.S. equities today because of valuation concerns, especially relative to other global equity markets. But another way of reading that is that higher interest rates have hurt other asset prices, so they’re likely, at least eventually, cause some sort of correction in U.S. stocks as well.
The stock reactions during the upcoming earnings season could be an early indication of whether U.S. equity investors are indeed over-their-skis. So far in 2014, while the one-way bull train has stalled, the broader indices have weathered potential negative catalysts (like Friday’s jobs report) quite well.