Why Continued Calm for Stocks Depends on Credit Markets

Can markets repeat the outstanding performance of 2017? Russ discusses why credit market conditions are likely to provide the key clues.

Calm. Still. Halcyon. Serene. Placid. These are just a few of the adjectives that will invariably be used to describe last year’s stock market. In this case however, numbers, two in particular, illustrate better than words. According to Goldman Sachs, realized volatility for the S&P 500 was 6.7% last year, the second lowest on record. 2017 was also the only year on record in which the S&P 500 delivered a positive total return in every month of the year. A 20% return with no downside is literally as good as it gets.

Which of course leaves investors wondering if there is even the slightest chance we’ll be equally lucky in 2018. While the list of scenarios and events that can disrupt markets is endless, there is at least one quantifiable metric to watch: financial market conditions measured by credit spreads.

In the long term, valuations and the economic cycle, i.e. recessions, tend to drive performance; in the short term, both are less critical. In trying to forecast more common, “garden variety” corrections, financial market conditions have historically been more relevant than the next economic release. From my perspective, one big reason why 2017 was such a calm year for stocks was that it was an exceptionally calm year for credit.

Steady as she goes

To illustrate, it is useful to compare 2017 with late 2015/early 2016. Last year, credit markets turned in a remarkably steady performance. Not only were credit markets well-behaved on a year-over-year basis, they were calm throughout the entire year.