'Tis the year without volatility

Investors enjoy big rally with few shocks – but drama ahead

By Jason Kephart

Dec 3, 2013 @ 12:01 am (Updated 3:51 pm) EST

volatility, vix, cboe, equities, stocks, dow jones industrial average, s&p 500, shocks, federal reserve, europe

It's been a wonderful year to be a stock investor. Not only is 2013 shaping up to deliver the best returns of the past 10 years, it's also offered one of the smoothest rides.

The S&P 500 is up just over 27% through Monday, putting it on pace to be the best single-year return since the 28.7% it climbed in 2003. What's made the returns even better, though, is the fact that they've come with the lowest volatility since before the financial crisis.

The Dow Jones industrial average, for example, has had only 24 days in which it finished up or down 1% or more, according to the December issue of the Independent Adviser for Vanguard Investors. That's the fewest such days since 2006. There also have been only four days that the blue-chip barometer finished up 2% or more; again, the most since 2006. The median number of days with 2% moves or more from 2007 to 2012 was 42.

The Chicago Board Options Exchange Market Volatility Index, a measure of implied volatility that's commonly referred to as the "fear index," closed Monday at 14.24, down from its average of 21.32 since March 2009, when the stock market bottomed.

Investors have both lady luck and central bankers around the world to thank for this year's friction-less returns.

“We've dodged some bullets this year,” said Russ Koesterich, chief investment strategist at BlackRock Inc. “We didn't have the repeated shocks there were over the last five years.”

MORE DRAMA AHEAD

During the past five years, there have been numerous worries about Europe and Congress.

Even though those worries haven't completely abated – there's more debt ceiling drama on deck – they have been overwhelmed by the unprecedented liquidity that central bankers are pumping into the global economy, said Kristina Hooper, U.S. investment strategist at Allianz Global Investors.

“It's had an incredible calming effect on the markets,” she said of the fiscal stimulus.

The Federal Reserve Bank is expected to start cutting back on its asset purchases soon, though, possibly as early as later this month.

That could mean that volatility, or at least historically average volatility, is right around the corner, Mr. Koesterich said.

“Liquidity has gone a long way toward dampening volatility,” he said. “As that starts to fade, you're going to see a resumption of volatility. That doesn't mean going back to 2008 levels, but even a reversion to the mean is going to feel like high volatility given how low it's been this year.”

Advisers will have their work cut out for them keeping clients calm once volatility does return, especially with so many investors just starting to warm back up to equities again.

“Much of their job is going to be about educating clients about volatility and make sure it doesn't cause them to be more risk adverse,” Ms. Hooper said.