News can be disturbing these days with tragic events, threats of war, destructive weather conditions and questions of character in our business and political leaders. We often judge how well the country is doing based on highly emotional events that gain our attention. By this standard, things are going poorly.
Moving beyond these emotionally charged events, it’s been very good news this year on the economic and financial fronts, with a strong economy and a tranquil stock market. Indeed, as we look back over the last 50 years, there is no other period sporting such a marvelous combination.
A Strong Economy
By almost any measure, the economy is hitting on all cylinders. The Institute for Supply Management Manufacturing and Non-Manufacturing indices are both are very strong, well above the expansion indicator and the Non-Manufacturing index at a 12-year high. GDP growth exceeded 3 percent in both the second and third quarter, the first time in a number of quarters. Other indicators such as interest rates, unemployment rate, wages, company and individual balance sheets, and corporate earnings also are signaling strength, in some cases the best seen in decades.
One of the most fascinating turn of events is that inflation has remained docile as the economy has strengthened, confounding the Fed and virtually everyone else. As we all learned in macro-economics 101 way back when, there is supposed to be an inverse relationship between the unemployment rate and inflation: when the unemployment rate drops to historically low levels, as it has recently, inflation should heat up. But it hasn’t. This is of course very good news.
In a recent Wired article, Zachary Karabell argues that technology and intense international competition may have left inflation back in the 20th century. If that is the case, it bodes well for future economic growth and stability. Regardless, we should relish the current combination of strong growth and tame inflation, something we have not seen in decades.
A Tranquil Stock Market
The good news emanating from the economy has not been lost on the stock market, as it has hit one new high after another, leading to one of the strongest bull markets in history. But more surprising is the relative tranquility of the current market. Measures of market volatility, such as the CBOE Volatility Index (VIX), have been declining in recent years with a record low on Black Friday. Cross-sectional measures of individual stock return volatility have also been declining and are currently at all-time lows. This means individual stock returns each month are bunched together like never before.
Looking over the last 50 years, we have not seen this combination of intertemporal and cross-sectional stock market tranquility before. As a comparison, during the 1990’s bull market, of comparable length as the current bull market and also supported by a strong economy, both intertemporal and cross-sectional volatility were many times higher than they are today. The 1990’s stock market delivered outstanding returns but took investors for a wild ride.