What to Make of Markets Calm During Political Storm

For investors, it won’t be until real trouble shows up that they are likely to react

By Justin Lahart
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A currency trader watches monitors at the foreign-exchange dealing room of the KEB Hana Bank headquarters in Seoul. Photo: Associated Press


The world seems a very uncertain place lately. But try telling that to the stock market.

To judge from the news headlines, the past year has been full of dangerous surprises. Last winter a thicket of debt, emerging market, dollar and commodity-price woes sent off recession warnings. Next, there was Britain’s vote to leave the European Union. And then the upending of the U.S. political status quo in the election of Donald Trump.

Indeed, as measured by an economic policy uncertainty index developed by economists Scott Baker, Nick Bloom and Steven Davis, this counts as a perilous period. Yet the stock market hasn’t only been unusually calm, it has been calmer than usual. The standard deviation of the S&P 500’s daily moves in 2016—its typical swing—was 0.8% versus 1% in 2015. Last quarter, the stock market posted its calmest performance in a decade.

The decline in volatility has been matched by a decline in the Chicago Board Options Exchange Volatility Index, or VIX. The VIX measures how much options to protect against volatility cost; right now those costs are low, suggesting investors aren’t worried about what is coming down the pike.

It is an odd situation. The policy uncertainty index is based on criteria including flagged word combinations in news articles and the level of disagreement among economic forecasters. In the past, when it has been high, stock market volatility and the VIX have been high as well.

Volatility has always been a bit of a puzzle—stocks shake around a lot more than the underlying fundamentals suggest they should. But now would be a funny time for the market to start acting the way financial theorists say it should. Another possibility is that stock-market investors don’t care all that much about politics, and since the recent round of uncertainty is political in nature (as opposed to the uncertainty surrounding the 2008 financial crisis), it isn’t hitting stocks.

The problem there, says Mr. Bloom, is that the market clearly does care about politics—witness its move since election day. He thinks a more likely reason volatility is low is that the hurdles the economy could face in the new political climate, such as the erection of trade barriers or a hard tack against immigration, aren’t going to come about in the very near term.

Put different, investors aren’t looking much further than the end of their noses, and it won’t be until their noses run up against real trouble that they’re likely to react.

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