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In One Chart - June 26, 2019

In One Chart: Setting New Highs Despite Volatility

“A smooth sea never made a skilled sailor,” as the adage goes.

While varying forces have thrashed investors every which way over the last couple years, stocks have stayed their course as the market has continued to set new highs.

With trade wars, tariffs, and now conflicts with Iran, one might assume that equities markets would be volatile, and further that increased volatility would prevent the market going higher; however, the past 18 months have proven otherwise.

Since the beginning of 2018, the Cboe’s VIX (often called the fear index), has averaged 16.4; in 2017, the VIX averaged 11.1. That increase signals that the market has become more bearish in its expectations for growth. And yet despite lowered expectations, the three major indices have continued to find ways to set new all-time highs.

The chart below shows the Dow Jones’S&P 500’s, and Nasdaq’s percents-off-high over the last three years. There is a marked difference in behavior prior to January 2018, with percents-off-high moving erratically up and down since that time. Most dramatically, the indices were about 20% lower than their previously set highs in December 2018.

The market is currently facing headwinds, namely the US-China Trade War, additional tariffs on Mexican imports, and tensions with Iran surrounding nuclear sanctions, that have continued to make investors uneasy and contributed to sell-offs in December 2018 and May 2019.

At the same time, tailwinds that have pushed the market higher despite volatility include historically low unemployment, strong corporate earnings, and the Fed’s dovish approach to interest rates.

So will stocks go higher in 2019? There are reasons to be optimistic. Increased volatility can be a sign of hedging and bearishness, but it’s not necessarily indicative of a down market.

At their June meeting, the Fed left the Federal Funds Rate target range unchanged, but stated it would “act as appropriate” to spur further economic expansion — that statement put new wind in bulls’ sails. There’s also hope for the US-China Trade War as President Trump and Premier Xi Jinping have agreed to special one-on-one talks at the G-20 Summit in Japan on June 28th and 29th.

Additionally, while some see historically low unemployment as a sign that the economy is overheating, US Productivity grew by 3.4% in Q1 of 2019 and has increased in nine of the last ten quarters. As long as productivity continues to grow, there is less merit to arguments that the job market is becoming too tight.

While the market has proven capable of fighting through volatility, it’s come at a cost. Volatility was historically low in 2017 and the S&P 500 picked up 19.4% in that year. Since the start of 2018, relatively high volatility has kept the market’s growth to just 10.2% over almost 18 months. That said, there’s a big difference between a 10.2% gain and a down-market.

Volatility has dampened returns without stifling them completely, and while investors shouldn’t expect clear skies and calm seas for the rest of 2019, there is a course charted for growth.

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