complacency built, and building

18 Feb

Yesterday, the NYSE saw 365 new 52-week highs and just 9 new lows.

How much longer can this relentless, low volatility run continue? Since the end of September, we have seen only six days where the market has declined by 1% or more (just two of those this year). And the last time the market declined 2% or more was on August 11th — and it’s happened only twice since the end of June last year! That’s a long time to go without substantial downside volatility.

Now, it’s one thing to see the market climbing but we must consider its context. To do that we juxtapose this against prevailing valuations. On that front, it’s not encouraging. The S&P 500 stands at 18.5x earnings (over 24 cyclically adjusted) and is discounting decade-ahead per annum returns under 5% (1.8% of which is from dividends). Sure, interest rates are low which means stock *should be* worth more, but I don’t buy it because investors can revise their return expectations relatively easily (and quickly).

So volatility is low and valuations are elevated, but the market keeps going up?

“It feels safer.”

“There is money to be made.”

Low volatility to the investor, to borrow from N.N. Taleb, is like the farmer feeding the soon-to-be-Thanksgiving-dinner turkey. Just as the safety appears greatest (based on backward-looking data), the danger is actually at its highest.

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