Thursday, July 20, 2017

Markets’ Steady Climb In 2017 Defies Historic Odds

Major indexes haven’t gone a calendar year without a pullback of at least 5% in at least 30 years.

By Steven Russolillo
The Wall Street Journal
July 20, 2017

Stock markets go up and down: It is a fact of life. Except in 2017.

Three major stock-market benchmarks in the U.S., Europe and Asia have avoided pullbacks this year, commonly defined as 5% declines from recent highs. Never in at least the past 30 years have all three indexes—the S&P 500, MSCI Europe and MSCI Asia-Pacific ex-Japan—gone a calendar year without falling at some point by at least 5%.

In good years and bad, markets tend to fluctuate wildly, with stock indexes often falling by double-digit percentages before bouncing back. That hasn’t been the case this year, another reflection of the historically low volatility that has gripped the world. The CBOE Volatility Index, or VIX, finished Friday at its lowest since 1993.

Of course, 2017 is only a little more than half over, and plenty can change in the back half of the year. But the last time equity markets went this deep into a year without all three of those benchmark indexes suffering at least 5% pullbacks was nearly a quarter-century ago, in 1993, according to The Wall Street Journal’s Market Data Group. All three finished that year with sharp gains.

Many investors say they are optimistic that the steady grind higher will continue and defy historical odds that suggest the markets should eventually falter. That is because earnings growth appears to be accelerating globally, economic growth is improving and central banks largely remain accommodative, even amid recent moves to tighten policy.

The rise of quantitative trading and the flood of money into passive strategies such as exchange-traded funds have also dampened volatility, investors and strategists say. ETFs owned nearly 6% of the U.S. stock market in the first quarter, the highest share on record, according to an analysis of Federal Reserve data by Goldman Sachs.

Market calm has prevailed despite political and monetary turmoil. The U.K. vote last year to withdraw from the European Union, U.S. President Donald Trump’s election victory in November, the European Central Bank’s signal last month that it would soon start winding down its giant bond-buying program—none produced the sustained market swings many expected. That has raised concerns there might be another, less-well-understood dynamic at play that has kept trading so tranquil.

The steady performance hasn’t been universally celebrated. Some investors who have missed out on this year’s sharp rally are waiting for cheaper opportunities to get back in. Others are increasingly taking positions in the options market that protect themselves from large price swings.

“We all want markets to go up forever and for there never to be any problems,“ said Daniel Morris, senior investment strategist at BNP Paribas Asset Management, which has about $661 billion in assets under management. “But this environment has been a challenge for equity investors who are looking for growth at a reasonable price.”

The MSCI Asia-Pacific ex-Japan index, a benchmark that tracks big Asian companies listed globally, has surged 22% in 2017, propelled by strong rallies in tech giants such as Tencent Holdings Ltd. and Alibaba Group Holding Ltd.

The index’s biggest peak-to-trough decline during the year was 2%. If that performance continues for the rest of the year, it would be the smallest intra-year drop over at least the past three decades and a far cry from the index’s average 20% pullback each year, according to analysts at J.P. Morgan Asset Management.

Indeed, there have been only three instances over the past 30 years in which the Asia index’s biggest intra-year drop was less than 10%: 1991, 1993 and 2005.

Europe’s performance, measured by the MSCI Europe Index, has also been steady. The index’s biggest drop this year was 4%, far below its average intra-year decline of 16%, according to J.P. Morgan Asset Management.

And in the U.S., sharp gains in tech and consumer stocks including Facebook Inc., Apple Inc., Inc., Netflix Inc. and Google parent Alphabet Inc. have propelled markets higher alongside shallow and brief dips.

The S&P 500 has gained 10% this year. Its worst peak-to-trough drop has been 2.8%. If it finishes 2017 that way, it would be the second-smallest decline in a calendar year over the past 60 years, according to LPL Financial, an independent brokerage and investment firm. The smallest was in 1995, when the index suffered a 2.5% fall. It surged 34% that year.

History suggests the stretch of calm won’t last. The S&P 500 has avoided a 5% or more pullback in just five of the past 60 years, according to LPL.

But for now, the catalysts that have propelled the rallies and minimized the pullbacks remain in place, including low odds of an imminent recession and strong earnings growth. The ratio of analysts revising their global earnings estimates higher rather than lower recently jumped to its highest level in about five years, according to Richard Turnill, global chief investment strategist at BlackRock, the world’s largest asset manager.

“The reality is central banks continue to be accommodative and the global earnings picture keeps on improving,” says Ryan Detrick, senior market strategist at LPL Financial. “Those two things can make up for a lot of other sins.”

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