After a brief stumble, the stock market returned to its upward march in May. Investors are not being affected by the continued onslaught of news coming out of Washington. Despite the daily barrage of talk about policy shortfalls, classified information leaks and deteriorating foreign relations, the ‘Trump Bump’ has not been reversed into the ‘Trump Slump.’ In fact, investors seem less impacted by all these news events than they ever have been. When Donald Trump won the presidency in November, one bet seemed like a sure thing: We were in for a volatile few years. While that prediction has definitely come true in terms of the events in Washington, it has not translated into any fear on Wall Street about the outlook for the economy or markets. Prices for stocks and many other assets are less volatile than at any time since before the global financial crisis a decade ago. Investors learned a lesson that it’s easy to overreact to political developments, even the talk of impeachment of a sitting President less than six months into his first term.

Stocks in the United States have seldom risen for so long without a major setback and have never been more expensively valued, outside the tech boom of the late 1990s. History shows that bull runs tend to last until the next recession starts, so the question is where the next downturn comes from. If emerging inflation pressures prompt the Fed to raise interest rates more quickly, the economy could stumble and take the market with it. There are also still threats to the world economy, including China’s debt bubble, which has taken debt in the world’s 2nd largest economy from 150% to 250% of national output over the past ten years. If it bursts, it could cause the next global recession, which would hit stock markets hard. So there is much to worry about in the markets, but the cloud of scandal around the White House does not seem to be high on that list. Trump’s mercurial ways may be a source of great daily news bites on CNN and the like. But investors don’t seem to care one way or other, for now.

Risk in the stock market has always been quantified by the level of volatility in stock prices. If that measure is accurate, then it has to be said that investors currently see very little risk in the stock market. In 2015, the S&P500 moved by more than 1% on 29% of trading days. Last year that fell to 19%. So far in 2017, there has been a 1% or greater swing in the market in only 3 trading sessions, or 3.5%. On May 8th the VIX (stock volatility index) finished at the lowest level in its 27-year history! The problem with all of this complacency is that it could make banks, hedge funds and other institutions more comfortable taking on extra leverage, paradoxically making the financial system less stable and more subject to larger swings over time. While low volatility, in and of itself, does not create market risk or signal a downturn, the chart below shows that stock market tops have always created during periods of low volatility and the ensuing bottoms occur after volatility spikes much higher. The problem for investors is that this period of low volatility can go on for a long time and doesn’t start to rise until stocks begin to fall. The bottom line is that stock volatility is a ‘lagging indicator’ of downturns in stock prices. It is a much better tool for finding stock market lows!

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