The stock market has not been so quiet for years

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WSJ.com: Markets

The US stock market is as calm as it can be on the surface, while underneath it is seething more than it has been for decades.

The S&P 500 is so quiet it’s almost unsettling. The index has not experienced a 5% correction on the basis of the closing prices since the end of October; No wonder the new day traders who started buying stocks in lockdown think the market is only going up. The last time the S&P was so calm for so long was 2017, a period of calm that ended with the volatility crash in early 2018 – although it was still much longer then.

Look at the performance of the stock types, however, and they fluctuate a lot more than usual. Investors have switched their bets between industries at a pace not seen outside of crises; March saw the biggest gap between the best and worst performing sectors since 2002.

The link between the movement of growth stocks and cheap “value” stocks is, as measured by correlation, the weakest since 1995; Investors use them as a proxy for betting on or against the economic recovery.

Meanwhile, big and small stocks last moved so independently during the dot-com bubble in 2000, never a comforting sign.

I think this is another aspect of TINA: there is no alternative to stocks. With treasuries, corporate bonds, and cash offering meager or no return, stocks offer the best prospects for profit. Investors who would previously have shifted money from stocks to bonds or vice versa are now simply switching from one type of stock to another – so declines in one stock are offset by gains in another.

There is of course no guarantee that this will continue. Bring enough fear into the game and investors will be preparing to exit no matter how low the cash yields are, just like they did last March. But while times seem pretty good, buying a long-dated bond that is way below inflation is hard to justify. And times seem pretty good.

Stocks popular with retailers like GameStop have been some of the most traded lately.


Photo:

Carlo Allegri / Reuters

A popular theory among those on the cautious is that stocks just keep rising because a massive bubble has been inflated by cheap money and government incentives. Stocks haven’t been that expensive since 2000, while a bubble mentality is evident with fashionable stocks raging wildly. A group of small stocks popular with retailers have often topped the most traded lists this year, notably GameStop and AMC Entertainment, but also favorites like Virgin Galactic and BlackBerry.

It is undeniable that stocks are far more expensive than usual. But bubbles usually involve a lot of volatility when they puff up, not a calm exterior and turmoil inside, because every little drop in price is magnified by others who fear the bubble is about to burst. In 1999, the S&P 500 saw at least nine declines of more than 5%, falling 13% from its intraday high in July to its October low.

This time around, the most obvious threat to stocks is the Federal Reserve, not the overvaluation of the market. When the Fed hikes rates, all of a sudden, cash and bonds look a lot more attractive and TINA’s justification for buying extraordinarily expensive stocks is undermined.

“The market is very volatile, but not a lot of market volatility,” said Robert Buckland, chief global equity strategist at Citigroup. “If there is an alternative to owning the index, that could change.”

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Fear of the Fed this month has shown how sensitive stock prices are if it turns out that there is some sort of alternative to stocks. The Fed lifted rates slightly off the ground by offering 0.05% instead of 0% of its cash-absorbing reverse repo, a type of overnight collateralized deposit, and immediately sucked in an additional $ 235 billion. Talk of rate hikes coming in two years from the previously forecast three put pressure on stocks and the S&P fell just over 2% in three days before resuming its bullish trend.

If that was in response to the Fed doing next to nothing, imagine how scared the market would be if the Fed embarked on a normal rate hike cycle and made cash attractive again. I don’t think that’s likely anytime soon, but the biggest threat that the turbulence could bring to the surface from the depths of this market is the Fed.

Write to James Mackintosh at james.mackintosh@wsj.com

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