One recent development in the stock market is how much recent day to day price moves have lessened.
Anyone who has followed the market in recent years is certainly aware of how it has fluctuated, since the financial crisis occurred in 2008.
A popular measure of stock market volatility, called the VIX, is actually now at its lowest level since before the financial crisis began.
The reason for the importance of the VIX is that the stock market is highly correlated to changes in that index. For example when the index is at a low level, as it is currently, the stock market tends to do well.
Likewise during crisis periods when the index is elevated the stock market is depressed.
The reason this relationship holds is because people, as a general rule are risk averse. When the market is experiencing large day to day gyrations, there is tendency for investors to pull money out causing the market to decline.
Likewise during calmer periods people are more willing to invest in riskier assets.
This raises the point as to what has caused the recent decline in market volatility. There really has not been one obvious factor, but actually several , which have allowed for this period of relative market calm.
Europe has been the principal culprit of market turbulence the past two years. While recent economic news from that region remains depressed, there is a greater feeling that European authorities will do more to avert a major collapse.
Also bond yields in Spain and Italy have recently declined, indicating somewhat more stability.
In the U.S. during the second quarter of this year there were renewed fears of a recession based on disappointing economic data. Recently the data has been a little better helping to alleviate some of those fears.
However, our economy is still experiencing below normal growth.
Finally, the month of August is vacation time for much of Europe and the U.S. investment community.
Even this writer has been out of town a couple of times in recent weeks. While there have been times in August of significant market volatility in prior years, there is a tendency for more calm when key decision makers are on vacation.
The high levels of government debt plaguing both Europe and the U.S. are still present. While the odds of another major financial crisis have lessened in recent months, Europe’s major problems are far from being solved.
While I would not expect volatility to increase in a major way, investors need to realize there will be future periods of market turbulence.
Even with the recent strong market stocks are still relatively inexpensive compared to bonds.
However, it is important to recognize that stocks are still risky assets, and periods of market calm may be a good time to trim holdings, if they have become larger than normal.
