This Hasn’t Happened Since 1995

Record low correlations between stocks are very likely to increase after the tax reform gets fully priced-in in the second half of 2018. We estimate this will push index volatility up by ~3 points. Perhaps the best example of the impact of correlation on reducing S&P 500 volatility was the market move on Nov 29, when financials and technology stocks moved ~4% relative to each other leaving the S&P 500 index price unchanged (~5 sigma move).

That’s from JPMorgan’s Marko Kolanovic and it underscores the extent to which declining stock correlations have served to tamp down volatility. The VIX was ~10 points below its historical average this year, and according to Kolanovic’s estimates, roughly 1/3 of that is attributable to declining stock correlations with another 1/3 attributable to the supply of volatility and daily gamma hedging and the remainder to positive macro fundamentals and stability.

You know the story. Everyone does. But with the exception of Bitcoin, no other topic has received more attention in 2017 than the low vol. “mystery”. Of course it’s really not a mystery. When you take the factors listed above and set them against a backdrop of central bank transparency/predictability (a source of volatility supply), it makes sense.

Are things set to change materially in 2018? Who knows. The controlling factor here (i.e. short-termism engendered by policymaker transparency and the local stability that myopia creates by optimizing around the prevailing dynamic) is deeply ingrained and without something (e.g. inflation) forcing central banks to withdraw transparency, it’s difficult to see how change is possible.

Still, everyone is going to keep writing about it. Case in point is a Bloomberg piece out Friday called “This Was the Kind of Week Morgan Stanley Sees Going Away in 2018.”

Steady growth and predictable profits and central banks are all things that are going to change next year, Morgan Stanley’s chief U.S. equity strategist, Mike Wilson, told Bloomberg in an interview. To wit:

We’re going to get more dispersion in earnings estimates, we’re going to get more dispersion in economic data, not quite as synchronous, we’re going to get the Fed tightening policy. We should expect more volatility.

Ok, Mike – we’ll see.

The reason we bring this up on Sunday is actually to draw your attention to another fun “longest since” moment. As Bloomberg notes in the piece linked above, the S&P has gone 68 sessions without a 1% in either direction:

That’s the longest streak since 1995. “When historians look back on the 2017 stock market, it will be weeks like this that they remember,” Bloomberg goes on to write, before summing up the week as follows: “three up days, two down, volatility nowhere in sight, and a wire-to-wire gain of less than 1 percent.”

Indeed.