In a shortened trading week due to MLK Jr. Day (where volume is typically expected to be lighter than average), stocks in the US ripped to new all-time highs. The benchmark S&P 500 index, which represents 500 of the biggest and most profitable companies in America, is currently up 4.11% for the year.
Keep in mind, there have only been 11 trading days thus far in 2018. Suffice to say, US stocks have officially crashed up – this is not a joke. This is the best start to a trading year in, well, the history of the stock market.
S&P 500 1YR Performance
Nasdaq Composite Index 1YR Performance
Dow Jones Industrial Average Index 1YR Performance
Why Does the Stock Market Keep Going Up?
The short answer is: American companies are becoming more profitable, or at least, investors are expecting American companies to become a lot more profitable in the next few years.
The thought of tax cuts, the scrapping of regulation, and favorable business rules are starting to seriously have an impact on the stock market.
To put the current YTD ROI for the S&P 500 into perspective, in 2015 and 2011, the S&P 500 only returned 1.38% and 2.11%, respectively. And this was after a whole years worth of trading… The S&P has already doubled these figures in just 11 trading days.
Will the Rally Last Forever?
It will most certainly not last forever, at least, we think. The stock market is like the game of musical chairs. It’s all fun and games when the music is playing. However, when the music stops playing, there are never enough chairs for everyone. In this case, when investors decide to run for the exits, there is mathematically not enough room for everyone to realize their profits on their investments. As such, this always has a negative impact on the price of securities.
The key to knowing when this historic rally will stop is, in our view, identifying what geopolitical and macroeconomic events cause the music to stop playing, so to speak.
What is Volatility Doing?
Volatility, as measured by the VIX Index, which measures the volatility of S&P 500 options, is surprisingly not at an all-time low, even though the market is at an all-time high.
The VIX Index printed at an all-time low of 8.56 on November 24th, 2017. Currently, it’s hovering around 11.24, which is surprising. This is somewhat indicative of fear in the marketplace. Because volatility is not, technically speaking, cheap, this means investors are willing to pay more money in options premium to protect their stock positions or speculate on the direction of the market.
Although this could be an upside “risk premium” it’s unlikely given that puts are still trading richer than calls int he S&P 500 index. Perhaps this means investors are expecting a pull-back?
An Possible Explanation: FOMO
Besides tax reform and deregulation, another explanation for the unbelievable start to 2018 might be something known as FOMO, or the fear of missing out. This is where individual investors, hedge funds, pension funds, and even endowments see that the market is up 2% for the year, and they are worried that it will continue to climb and they will miss out on the rally.
Subsequently, these investors buy the market when it is up 2% which causes the market to be up 3%. Other investors see the market is up 3% and are afraid they too will miss out on the upside, so they buy, which then causes the market to be up 4%. Obviously, it’s slightly more complicated than this example. Nevertheless, this concept of not wanting to left out when the stock market is going up has unequivocally contributed, if not outright caused, the market to rise.
Investment Tactics for All-Time Market Highs
When the market is at an all-time high, it’s incredibly difficult to buy into the rally, because nobody wants to buy the peak of the market. However, those who have been betting against the S&P 500, Nasdaq, and Dow Jones Industrial Average indices since 2016 have done nothing but lose money.
It’s impossible to definitively say where the market will go from here. The good news is, although volatility is not as low as it has been historically, it is still relatively cheap. This makes long options strategies look very attractive.
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