Investors fear long stretch of calm in markets can’t last

Stocks have been on a steady climb, with the S&P 500 up 14% nearly halfway through 2024 and closing at 29 records along the way. One-day index changes of 1% in either direction have been rare, and there has been just one 2% move, the fewest since 2017 through this point in the year.

The Cboe Volatility Index, or VIX, dropped below 12 last week, a nearly five-year low. Known as Wall Street’s fear gauge, the index tracks the price of options that can be used to hedge against stock-market downturns and measures how much traders expect prices to fluctuate.

Investors look sanguine, and analysts say they have good reason. The economy has remained stronger than almost anyone predicted after the Federal Reserve began raising interest rates. Corporate profits are rising again. Inflation cooled more than expected in last week’s consumer prices report, and Fed officials signaled that they expect to cut benchmark rates later this year.

Add in the artificial intelligence boom that’s driving huge gains for market darlings Apple and Nvidia, and investors have plenty to cheer.

But history shows that periods of extreme market calm rarely last. The VIX traded in line with current levels for most of 2005 to 2007, before surging above 80 during the 2008 financial crisis. Part of the problem with a strong economy and calm markets is that they create an environment in which investors let their guard down and turn to risker, more speculative investments in their hunt for fat returns.

“On a really calm day, it’s easy to blow bubbles. They can grow to humongous sizes," said David Kelly, chief global strategist at J.P. Morgan Asset Management. “When the wind picks up, they pop."

Investors are continuing to double down on bets that are working, particularly large-cap U.S. stocks in the highflying technology sector, because they are convinced the economy has staved off a recession, Kelly said.

This week, investors await retail sales data, the S&P survey of purchasing managers and speeches from half a dozen Fed officials. Traders will closely parse their comments for clues about the central bank’s path forward.

Since the bull market kicked off in late 2022, the S&P 500’s gains have been driven by a handful of megacap tech stocks. After widening earlier this year, the number of stocks leading the market’s advance has narrowed again lately, alarming some investors.

The S&P 500 would be down over the past 30 days, for example, if all the stocks were given the same status. Instead, the market-weighted index is up 4%. The 10 biggest stocks recently represented 36.8% of the index’s total value, the highest since September 2000, according to FactSet.

A narrow rally leaves the market vulnerable if a few of the biggest companies can’t meet the lofty expectations priced into their valuations, said Steve Sosnick, chief strategist at Interactive Brokers.

“If you’re very top heavy, it papers over a lot of other issues and can mask what’s going on under the surface," Sosnick said. “The markets have been driven much more by greed recently than by fear. The problem is that the longer that goes on, the more fragile it becomes."

Low trading volumes are another potentially troubling sign. The SPDR S&P 500 ETF Trust, the largest S&P 500 exchange-traded fund, has posted its 14 slowest days of the year in May and June, based on the number of shares changing hands, according to FactSet. Low volumes can suggest a lack of conviction among investors.

“There’s two things you’d like to see in a big market advance: solid breadth and solid volume. We don’t have either right now," Sosnick said.

The bond market helps explain why stock trading appears so calm. With no recession imminent and inflation down from a year ago, the benchmark 10-year Treasury yield is near its midpoint for the year at 4.2%.

If bond yields move significantly higher or lower, stock valuations would likely move as well. The S&P 500 is currently trading at 21 times its expected earnings over the next 12 months, above its 10-year average of 18.1. With multiples historically high, some investors are nervous that a positive surprise in markets might have less impact on stocks than a negative one.

“We have a lower range of monetary policy outcomes compared to a year or two ago. That’s the biggest driver of the calm right now," said Bob Elliott, chief executive of asset manager Unlimited. “We’re now talking about the difference between 2 and 3% inflation, not 2 and 7%."

It is hard to pinpoint what will break stocks out of their lull. Analysts note that, unlike the last time the market was this concentrated in the early 2000s, the biggest companies today are profitable and have strong balance sheets. And compared with the years leading up to the 2008 financial crisis, companies and individuals now hold much less debt.

War in Ukraine and the Middle East have heightened geopolitical risks, though for now investors are taking solace in the fact that the conflicts haven’t escalated further. Other risks include a sudden economic slowdown or a jump in inflation. But for many investors, the unknown is more frightening.

“It’s usually some exogenous shock that breaks us out. That’s why they call it a black swan," said Quincy Krosby, chief global strategist at LPL Financial.

Write to Jack Pitcher at jack.pitcher@wsj.com