Fizzy profits: Why it's no surprise that US stock market has turned nasty

Until this month, the scariest thing about the stock market was its uncanny calm and stability. Like the opening sequences of a classic horror movie, the market last year was relentlessly and unnaturally cheerful.
 
Well, now the ax has fallen and the stock market has begun a “correction” — financial jargon for a decline of at least 10 per cent.
 
The scariest thing about the market right now is the shocked response of traders who had become accustomed to the unsustainably placid conditions that have been unceremoniously swept away.
 
The precise timing of the market plunge was a surprise, and it has evidently unnerved some investors. But while it may seem harsh to say so, after so many months of fizzy profits, a downturn was long overdue.
 
“The movements we’ve been having the last couple of weeks may not be pleasant but they are entirely normal, on a historical basis,” said Ryan Detrick, a senior market strategist for LPL Financial.
 
Based on the historical record, “normal” in the stock market includes unsettling conditions of the kind we have been experiencing lately. More of the same is likely in the months ahead: gut-wrenching swings down as well as up, rather than the steady gains that evidently lulled some investors into complacency.
 
That is not a declaration that the market is in deep trouble. Far from it. I don’t know where stocks are heading in the weeks ahead, but I assume, based on history, that they will eventually rise. “Eventually” is a word with a lot of wiggle room, however. Markets tend to overshoot, up and down, and they could certainly plunge much further.
 
That said, a good argument can be made that the underlying stock market fundamentals today are better now than they were a few months ago. After all, the economy appears to be fairly strong in the United States and in much of the rest of the world, and corporate earnings have been rising. Higher earnings and cheaper stock prices are an appealing combination. Using classic definitions, stock valuations have markedly improved in just a few months.
 

Last summer, when stock valuations seemed too rich, I followed my own advice and began to rebalance my 401(k) portfolio, reducing the ballooning proportion of stock, increasing short-term bonds and cash. That kind of heightened caution still seems wise but stocks (in the form of index funds) are beginning to look more appealing.
 
Still, the current downturn is a harsh reminder: The stock market entails risk, pain and losses, and it isn’t for everyone. Whatever “normal” is, it is nothing like the benign stock market of late 2016 or 2017.
 
“What we have seen in the last week or two is minuscule compared with the amount of real risk that is coming in the months and years ahead,” said Salil Mehta, an independent statistician with deep experience in troubled markets and their consequences. He was the director of research and analytics for the federal Pension Benefit Guaranty Corporation and for the Treasury’s Troubled Asset Relief Program, which was set up to help stabilise the financial system in the 2008 crisis.
 
Mehta’s view, which I share, is that a stock market decline of the kind we have been experiencing was overdue and that there is probably even greater volatility ahead. My own admittedly hopeful perspective is that declines now may reduce and postpone extreme speculative excesses later. Such excesses eventually lead to big market crashes and real pain for the broader economy.
 
In that context, the marvelous market conditions of last year were dangerous precisely because they were so seductive. As I wrote in August, the stock market in 2017 was magical — so strangely sedate that it was statistically improbable. That relentlessly rising market was an outlier that could not be sustained.
 
Consider that since the election in November 2016 through January, stock returns, including dividends, increased every month. That was the longest such streak since 1928, when reliable records began to be kept, Detrick says.
 
And it’s not just that stocks moved up every month. They did so on a daily basis in the gentlest and steadiest of fashions. The average daily change in the benchmark Standard & Poor’s 500-stock index for all of 2017 was a mere 0.30 per cent up or down. That is the lowest number — and the most stable market, based on that metric — since 1964.
 
No wonder the stock market seems so unsettling in 2018. Through Thursday, the average daily change, up or down, was 0.84 percent. That is a big increase. Yet going back to 1928, the average has been 0.75 percent. The current market, which has been depicted as wildly disruptive is, basically, just an average one, Detrick said.
 
Recall that in June 2016, after British voters said they wanted to leave the European Union, the stock markets fell into what seemed, at the time, to be a major panic. Less than a week after that vote, though, markets resumed their rise. Since then, the American market, measured by the S.&P. 500, was in positive territory every single day — until the cumulative declines of 2018 pulled the index into the red on February 5 and into a correction on February 8. On Friday, the S&P 500 closed at 2619.55.
 
Even if the current downturn doesn’t deepen, some sectors are already feeling severe pain. Traders who had bet that calm conditions would continue have lost fortunes. In just two days, the assets in two funds that trade in instruments linked to the VIX — officially, the Chicago Board Options Exchange Volatility Index — shrank from a combined total of $3 billion to about $150 million. There are few indications so far that trading losses in those instruments — or in the battered cryptocurrency markets — have damaged the overall financial system, but that is a worry in a serious downturn. 

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