From Jan. 1, 2016, to Feb. 2 of this year, the stock market was on virtual cruise control. In this span of just 13 months, the Dow Jones Industrial Average gained 32 percent, the S&P 500 26 percent and the tech-heavy NASDAQ 37 percent. Moreover, this surge in stock prices was accompanied by a historic level of market calm.
However, this historic calm was shredded on Feb. 2 with the release of January’s employment report. The sudden and unexpected surge in reported wage growth triggered concerns of higher inflation and additional interest rate hikes. The resulting shock sent the Dow falling 2,325 points, or 8.9 percent, over the next five trading days. Since then, the financial markets have been trying to refine their estimate on how fast inflation will actually start to rise. Unfortunately, every few days or weeks we get conflicting economic data or news, fueling additional massive price swings in stock prices.
And then there’s President Trump’s proposed tariffs. On March 1, he proposed a 25 percent tariff on steel and a 10 percent tariff on aluminum imported into the U.S. On Thursday, March 22, he proposed a second round of tariffs — this one targeting China. But the risk of retaliation from China and subsequent rumors of a negotiated settlement sent the Dow on a whirlwind ride. In the four days following the tariff announcement, the Dow fell/rose as follows: -724, -424, +669, -344.
For all of 2017, the largest daily price change in the Dow was 372 points on May 17. But in the first three months of this year, we’ve already experienced greater daily price changes 12 different times, including two 1,000-point declines in just four days. So, what are the financial markets conveying to us about this rollercoaster ride of stock prices? Is this just a dip in the road, or is there a greater concern of an unwinding of the U.S. stock market?
To answer, we can look to the VIX Volatility Index, the preferred gauge of measuring volatility and uncertainty in the stock market. Known as the “fear index,” the historical average of the VIX is around 20. In 2017, the average index measure was just 11.09, the lowest yearly average in recorded history. For comparison, the VIX reached the 80s in the weeks and months that followed the sub-prime mortgage crisis in September 2008. Apart from a few days in the 30s in early February, the VIX has spent the last month-and-a-half hovering around 20. Yes, despite all the recent news about inflation, interest rate hikes and tariffs, the VIX has been sitting near its historical average. So, what are the markets telling us?
One oft-forgotten characteristic of the VIX is that it is not an indicator of current volatility. Instead, it is a forward-looking projection of expected volatility in the next 30 days. It’s not a crystal ball, but it does reflect the financial markets’ underlying consideration that an extremely healthy U.S. economy can buffer these current challenges.
The American economy is a durable entity that can absorb its share of punishment, including inflation, interest rate hikes and tariffs. Yes, there’s been a pullback from the incredible run-up in stock prices of 2017 and the aforementioned concerns can’t simply be discounted. But for now, the markets are finding some assurance in the fundamental picture of the U.S. economy. The labor market is averaging 200,000 new jobs a month. The unemployment rate is expected to reach 3.6 percent, a 50-year low. The Federal Reserve has repeatedly upgraded economic growth forecasts and corporate profits continue to grow. No, the recent volatility displayed by the markets is likely not a reflection of some great structural downturn in stock prices. But investors should certainly brace themselves for a bumpy ride.