Stocks Keep Calm Amid Carrying On

Jamie Dimon, the chief executive of JPMorgan Chase & Co., thinks the U.S. has some problems.

And not just a few problems: slow economic growth, declining real wages, low labor force participation, a shrinking middle class, high student loan burdens, high rates of felony convictions, reduced mortgage availability, poor educational system, crumbling infrastructure, a brain drain and excessive regulation. (Although Dimon says JPMorgan is doing great, thanks for asking.)

I suspect that most Americans would agree with the sentiment, if not the particulars. According to Gallup, just 29 percent of Americans are satisfied “with the way things are going in the U.S.” That’s up from a low of 7 percent during the 2008 financial crisis but well below satisfaction rates that topped 70 percent in the 1990s.

You wouldn’t guess anything is wrong by looking at the U.S. stock market. Stocks are famously volatile, but in recent years U.S. stocks have been eerily calm.

Standard deviation is a common measure of volatility — or the degree of the market’s ups and downs. A lower standard deviation indicates less volatility, and vice versa. The standard deviation of the S&P 500 has been 18.8 percent since 1926 — the longest period for which numbers are available. To put that in some perspective, the standard deviation of long-term government bonds has been 8.4 percent over the same time.

Over the last three years, however, the standard deviation of the S&P 500 has been just 10.4 percent through March — nearly half its long-term volatility and modestly more than that of bonds.

Which raises the question: Why is the market so calm while Dimon and many Americans are so anxious?

I looked at the S&P 500’s rolling three-year standard deviations since 1929 for clues. The first thing I noticed is that there’s nothing unusual about the market’s current calm. Stocks have behaved more like bonds many times, most recently in the years leading up to the 2008 financial crisis.

The second thing I noticed is that volatility tends to spike only during periods of economic stress. That was true during the Great Depression and during the brief recession that followed in 1938. It happened during the early 1970s when inflation unexpectedly rose from 3 percent in 1972 to 11 percent in 1974. And it happened during the recessions that followed the dot-com and housing bubbles.

The two exceptions occurred within a decade of each other. Volatility was surprisingly muted during the stagflation era of the late 1970s and early 1980s. And volatility was high during the 1987 market crash, despite few signs of economic distress.

Nothing else seems to bother the market. Volatility was low during World War II. The market was untroubled during the 1960s, through the Cuban missile crisis,  the assassination of President John F. Kennedy, civil rights protests and the Vietnam War — to name just a few episodes from that tense era. Volatility was low in the late 1990s when President Bill Clinton was impeached. And the market was quiet during the mid-2000s, when the U.S. fought two wars.

The relevance to the current environment is obvious. While the U.S. faces numerous challenges and one of the most politically charged environments in memory, the U.S. economy appears to be humming along — at least by traditional measures. Growth has been uninterrupted for eight years. Unemployment is at a historic low.  And profit margins for S&P 500 companies have averaged 8.5 percent since 2009 — well above the margins achieved during the dot-com and housing booms.

Ben Graham, the father of value investing, called the stock market a weighing machine — and what the market weighs is companies’ earnings. Those earnings rely on a stable and growing economy, which the U.S. has enjoyed for many years. Even if Dimon is right about the U.S.’s problems, the market isn’t likely to care until they start weighing on the economy and companies’ bottom lines.

Source: Bloomberg Gadfly,