Financial markets are not often as gentle and generous as they've been this year.
Just count the blessings the market gods have bestowed:
- The S&P 500 has returned close to 10 percent (including dividends) so far in 2017, and 19 percent over the past 12 months, with global markets climbing in harmony with U.S. shares.
- The ride has been uncommonly smooth, with scarcely a noticeable pullback along the way.
- Some of the most beloved and widely owned stocks are leading the charge — such as Apple, Facebook and Amazon — while passive investors have been kept secure by constant rotation among sectors supporting the broad indexes.
- Bonds have even done well despite widespread fears of a surge in interest rates, with conservative fixed-income funds such as Vanguard Total Bond Index on pace for a 5 percent full-year return for 2017. This has benefited holders of a diversified portfolio, who often expect to suffer a loss in their "safe" holdings when stocks are riding high.
Such a bounty of rewards has led to a new worry: that the markets have simply been too good for investors' own good.
Here's Bespoke Investment Group: "With the first half of 2017 nearly complete, investors really have gotten off easy in 2017. Inundated with headlines about scandals involving officials at all levels in Washington, stocks have seemingly done nothing but go up as the S&P 500 has 24 all-time closing highs since the year started."
Charlie Bilello of Pension Partners asks, "Is this as good as it gets? I don't know, but for investors it's pretty darn close."
By "this," he means the high-return, low-volatility backdrop, with equities and bonds appreciating together, corporate earnings rising and a relatively "easy" Federal Reserve.
Market observers point warily to how good things have been not simply to play the spoilsport role. Their main concerns are that the calm ascent of markets can lull investors into a sense of false security or will front-load market returns in a way that restrains long-term investment performance.
William Delwiche, strategist at Robert W. Baird, says: "There are multiple ways to describe the relative calm that stocks have seen in the first half of 2017: single-digit readings on the VIX [S&P 500 Volatility Index], the second-smallest peak-to-trough first half decline for the S&P 500 on record or the 250 days since the last 5% pullback. The effect has been to leave investors relatively complacent."
Certainly, some surveys of investors show elevated optimism, and measures of the positioning of hedge funds show high equity exposure. By definition, this leaves a narrower cash cushion and thinner psychological buffer against any market shocks.
Yet on the whole, investor attitudes and behaviors are not out of line with what one should expect given the sturdy run of stocks to successive new highs and the extreme lack of drama during the climb.
Each time the indexes stall or tech stocks wobble, retail investors turn cautious in their fund purchases and options trading. And it's worth noting that markets haven't been overly generous for years on end: The S&P 500 is up just 7 percent annualized over the past two years.
Brian Belski, strategist at BMO Capital Markets, says the market's record run "should make investors happy – right? However based on most of our client interactions, doubt and cynicism are reigning supreme as correction theories escalate the higher the market goes."
It's not that investors are fighting the tape aggressively, but, Belski continues, "we believe a majority of investors are increasingly managing their portfolios as if they 'need' to be invested versus 'wanting' to be invested."
This means they're chasing, with gritted teeth, the same crowded growth stocks that are "working," rather than betting on improving economic and corporate fundamentals.
This could leave the big money offside under a few scenarios. He figures either we'll get the much-heralded correction, allowing investors to "clear the decks" and reposition. Or growth will accelerate and force a rotation back to cyclical and financial stocks. Or the economy remains sluggish and "all-weather" growth stocks will get stretched even further, perhaps making the market more top-heavy or unstable.
Still, history suggests that starts to a year as quiet as this one tend not to blindside investors with nasty surprises in the second half.
Bespoke looked at all years since 1928 that saw the smallest "drawdowns" — meaning peak-to-trough pullbacks. There were 16 years with maximum first-half dips of 5 percent or less. Of those, "the second half of the year also generally saw smaller than average drawdowns. Of the 16 prior years shown, the S&P 500 averaged a maximum drawdown of 6.3% in the second half, which is well below the average 12.2% decline for all years."
And the average second-half index gain in those 16 years was 7.8 percent — twice the average 3.9 percent gain for all years since 1928.
Now, the market did tend to get a bit choppier in the second half: In 13 of the 16 similar years, the deepest second-half drawdown exceeded the largest first-half dip. And the most recent such year, 2015, saw a sharp 12.2 percent correction beginning in late summer.
So, as ever, the market offers no guarantees of comfort or satisfaction. After the numbing upward grind of the past few months, even the average 6.3 percent second-half setback in those "calm" years would probably seem pretty unnerving. From the recent S&P 500 high, in fact, such a drop would take the index back to 2,300, undoing five months' of gains.
If we don't get a correction soon, it will mean that long-term investors — especially young ones — will be denied a chance to take advantage of volatility and add market exposure at cheaper levels.
But we don't get to choose our path through markets. And having it good now often means some form of payback down the line.