Newspaper article International New York Times

A Great Ride, but Reality Is Returning

Newspaper article International New York Times

A Great Ride, but Reality Is Returning

Article excerpt

The long rally fueled by the Federal Reserve's bond-buying program is one to remember, but sooner rather than later storms will return.

It has been the kind of year that makes an average investor feel like a genius: You could just put your money in a stock index fund and watch the market speed ahead. Why not take a few moments to savor it?

Let's reflect on how remarkable the American stock market has been lately, and on how well it has been weathering the first few days of a late-December shift in Federal Reserve policy.

And then let's get used to worrying again, because stormier times are coming, probably fairly soon. What we've been experiencing is outside the typical range of market behavior over the past 100 years.

"The biggest surprise in 2013 has been how powerful the market rally has been in the United States," said Seth Masters, chief investment officer of Bernstein Global Wealth Management. "And the second-biggest surprise is how few things went wrong, how low volatility has been -- and, obviously, those two surprises are connected." Mr. Masters remains bullish on the stock market for the next few years -- but he expects that we will see much bigger fluctuations, including some sizable declines, along the way.

Because we've been living through it, we may not see how special the market has been. At the opening bell of 2012, it began rising and didn't go below that starting level for the rest of the year. The same thing happened in 2013. With a notable exception last spring, the trend has been relentlessly upward.

The Standard & Poor's 500-stock index has returned 30.2 percent so far this year, including dividends. If it maintains that level through Dec. 31, this will be the best year since 1991, when the index returned 30.5 percent, according to data compiled by the Bespoke Investment Group.

But even those outstanding numbers don't really do the market justice. The steady upward bias and the lack of sharp declines, or tail risk, are extremely unusual. After all, the market has risen without having a single day with a decline of 3 percent in either 2012 or 2013; typically, there would be more than three such days in a period that long, according to the calculations of Salil Mehta, an independent statistician and econometrician who teaches at Georgetown and writes the wonky blog Statistical Ideas.

Mr. Mehta says tail risk has been so thoroughly suppressed that many investors have undoubtedly forgotten the gut-wrenching volatility that is a normal part of the stock market experience. If you began investing in stocks only in late 2012, you've never experienced that kind of pain, but if you stay in the market long enough, you can certainly count on it.

What caused the preternatural calm in the markets? Cause and effect is rarely clear when it comes to the performance of the entire array of stocks and bonds. …

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