The Stock Market Is Quiet. Too Quiet.

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All quiet on the financial front.Photo: Drew Angerer

It’s been a long time since you’ve read a hair-raising story about volatility in the stock market. But fear not, financial-scare lovers! The market has now been serene for so long, you actually have cause to worry about the calm.

The past 30 days of trading on the S&P 500 were the slowest of any 30-day period in the last 20 years, The Wall Street Journal reports. That makes some analysts nervous. Periods of extreme calm in the market have often signaled a coming storm. Among the points in recent history when the market approached its current level of stability was January 2007, months before the collapse of Bear Stearns.

The Journal’s James Mackintosh suggests two primary explanations for the present absence of volatility: First, after Britain voted to leave the European Union, most big players abandoned their biggest bets. Since they no longer hold aggressive positions, there’s less need to trade on what little financial news this summer has produced. Second, investors have grown complacent, owing to their faith in the Federal Reserve’s capacity to backstop asset prices. If you can count on the central bank to provide insurance against potential losses — by reinstating quantitative easing when equity prices fall — there’s less need to seek out trades that balance your risk.

Mackintosh cautions against such reasoning, warning that, while “policy makers will step in every time disaster strikes,” investors “tempted to rely on the central banks should note that disasters did still strike, and markets had big falls before help arrived.”

Beyond the market’s eerie quiet, there’s a more straightforward reason to anticipate a correction: If you believe the profit forecasts of U.S. companies, stocks are massively overpriced. The S&P 500 is currently trading at roughly 18 times next year’s projected earnings.

That’s the highest markup since 2002.

This optimism constitutes a bet against history. As the Financial Times notes, S&P earnings have now declined for four straight quarters — historically, such protracted declines have always brought on bear markets.

So, why are traders feeling so confident? The bulls argue that earnings have reached an inflection point — while earnings declined year-over-year in the second quarter, the decline was smaller than that of the first quarter. What’s more, the S&P’s earnings woes have been driven by aberrantly low oil prices that have bedeviled energy companies. Bulls believe oil will recover in the final quarter of this year and the sunny reality of the broader market will reveal itself: Strip out the energy companies from the S&P, and the market actually saw a 1.8 percent rise in earnings during the second quarter.

The FT finds this theory unpersuasive:

Against this, estimates for the current third quarter are actually still falling, and including energy, the brokers still call for a slight fall of 0.4 per cent. Earnings in the second quarter were better than expected, but they always are; they beat expectations by less than has been usual in recent years. If this is an inflection, the turn it signals is not at an acute angle … Add to this that US retail sales data suggest a sluggish economy, meaning that there is little reason to expect a big rise in revenues; that margins will be hard to expand; and that core inflation and earnings data suggest at least a whiff of inflation and a risk of higher rates from the Fed. Put all these together, and the highest prospective earnings multiples since the dotcom boom look like irrational exuberance.

In other words: August may be quiet, but winter is coming.