Nicholas Colas (DataTrek Research): Never leave a boring market
These phrases never hurt, although there are reasons why we should be cautious with a “rarefied air” in the markets, according to William Watts on MarketWatch.
When the volatility index VIX trades consistently below 20, the S&P 500 has performed well and has not seen annual declines, “he wrote. Nicholas Colas, Co-Founder of DataTrek Research, in a Tuesday note.
The VIX, an option-based measure of the expected volatility of the S&P 500 over the next 30 days, It was trading at 16.79 on Tuesday and has not traded above 20 since May 24.
Meanwhile, the stock market has been quite sleepy, trading largely sideways over the past two months, albeit with the DOW JONES Ind Average and S&P 500 nearing all-time highs.
The adage seems particularly timely, Colas wrote, “because we are seeing the S&P 500 tiptoes closer and closer to new highs with few tradable / shakeable pullbackss. That seems somewhat surprising, given all the chatter about inflation, downsizing, etc. “
So what does history show? Colas pointed to the chart below that tracks the VIX since the early 1990s and labels the markets when the VIX was constantly below 20 as “boring” and those consistently above 20 as “exciting”.
And here’s how the S&P 500 did it during the boring period, according to Colas:
1992 – 1996: +15 percent compound annual total return with no downtime years (although 1994, when the Fed began raising rates, was close, with only a total return of +1.3 percent)
2004 – 2006: +10.3 percent compound annual total return, with no downtime years.
2013 – 2017: +15.6 percent compound annual total return, and no downtime years (we give you a free pass to the sudden drop in ETFs of August 2015 – that’s the peak you see on the chart around 3 / 4s of the time series)
Tails recognized that the peaks in the VIX above level 40 have also historically been good buying opportunities, and noted that DataTrek has a permanent recommendation to start buying domestic stocks when the index exceeds that level.
In the meantime, there are legitimate questions as to whether the VIX has moved solidly into boring territory or is simply reflecting the “calm before the storm.”
“If one can create a specific, impending hit story ready to go on stage, then it’s reasonable to sell here even if the tape is ‘boring,’ Colas wrote.
The analyst described his opinion as “more cautious than openly bearish”, and noted that history also shows that the S&P 500 rarely recovers more than 10% three years in a row. A 12.5% gain so far this year leaves the market in “somewhat rarefied” territory.
“We’d like to see a ‘boring 5% market pullback,’ even if it’s not a short tradable opportunity, to allocate capital at better levels,” Colas said.