To say that the stock market has become a low-volatility game this year is definitely an understatement. For example, it has now been two months since the last time the S&P 500 dropped by 1% or more and according to Ned Davis Research, this is now the longest stretch without even a 3% pullback since the 1990's. So, my first point on this Tuesday morning is that it is important to recognize that what we're seeing now isn't exactly "normal."

Think about it; the stock market has had all kinds of what might normally be viewed as negatives thrown at it in 2017 including failures in Washington, political scandals, rate hikes, something now being called "quantitative tightening," some natural disasters, and even the threat of war. And yet, with the exception of a couple missteps along the way, stocks have marched steadily higher - especially over the last couple of months.

The question, of course, is why is this happening? Why have the bears been stymied to such a degree? And is this the new, new normal?

The easy answer is that the economy is doing just fine, thank you, the consumer is enjoying their "happy places" again, and corporate earnings are growing at a pretty good clip. Neither earnings nor GDP are great, but, as I opined yesterday, they appear to be "good enough" to keep the ball moving down the field.

I could probably leave the topic right there as it is oftentimes best to keep things simple in this business. And the bottom line here appears to be pretty simple - good economic growth and good earnings mean higher stock prices.

However, Morgan Sizer, the head trader at our firm (and a real pro!) came up with an equally "simple" answer to the question of why volatility has been so low this year.

Morgan offered his thought via our company's investment committee messaging network yesterday:

I have a theory. I was just thinking - I would guess that money flowing into passive funds is, for the most part, long-term. As such, there is money flowing into these funds every month for retirement contributions. The key is there is no fund manager who is reacting to news, earnings, rumors, etc., for these funds. Therefore, it makes sense that the bias would be for stocks to go higher with lower volatility. Before passive funds took over, you would have fund managers reacting to positive and negative news events and acting accordingly, adding to volatility and/or selling pressure. In conclusion, passive funds reduce volatility and add an upward bias to the market. Food for thought...

Morgan then followed up with a nice chart from BAML to illustrate to the group that passive investing has dominated fund flows for several years running.

View Image Online

The key to this chart is two-fold. First, money has been flowing into passive funds for some time now and these flows have increased significantly over the past five years. And second, actively managed funds - you know, the funds that tend to do better in times of stress - have seen serious outflows in five of the last seven years.

I've seen numerous reports on this subject and from my seat, there can be no denying that passive investing appears to be all the rage right now. And as Morgan opines, with the passive funds, there are no managers making decisions on where/when to buy/sell. No, there is only buying when new money comes in the door.

Is this the only reason that volatility has been so low recently? Probably not. However, my guess is that this is indeed ONE of the reasons that stocks have been grinding higher without so much as a garden variety pullback since just prior to last November's election.

Tomorrow, we'll run down some of the additional tailwinds that may also be helping the bulls move ever higher.

Thought For The Day:

If you wait until you're ready, you may be waiting the rest of your life. -Unknown

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

1. The State of the Earnings Season

2. The State of Tax Reform

3. The State of the Economy

4. The State of Fed Policy

Wishing you green screens and all the best for a great day,

David D. Moenning
Chief Investment Officer
Sowell Management Services

Disclosure: At the time of publication, Mr. Moenning and/or Sowell Management Services held long positions in the following securities mentioned: none. Note that positions may change at any time.

Disclosures

The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.

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