Stock-market volatility has subsided after a February spike, and theres a reason to think it will remain under wraps in the near term.
Thats because the exceptionally low volatility that prevailed in 2017 could be explained by the equally low correlation between S&P 500 sectors. A downward shift in correlation a measure of the degree to which assets move in relation to each other points to less volatility in the coming months, according to Nick Colas, co-founder of DataTrek Research.
The relationship between U.S. sector correlation and stock market volatility is very clear, Colas said.
When correlation is falling, it drives volatility down. But a spike in volatility, the kind we saw in February, drives correlation between sectors up, Colas said in a phone interview.
So the latest decline in volatility, therefore, has been driven by declining sector correlation.
The Cboe Volatility Index
or VIX, has fallen 40% since early April, settling at 12.34 on Tuesday, near its 2018 lows. Last year, VIX, which measures expectations for volatility over the coming 30-day period, spent most of the year below 10.
Similarly, the mean correlation for U.S. sectors to the index in 2017 was 0.55, about a third lower than the 2010-2016 average of 0.83, Colas said.
A perfect correlation reading of 1.0 would mean that sectors were moving in lockstep; a reading of 0 would reflect zero correlation, with sectors moving completely independently of one another. A reading of -1.0 would reflect a perfectly inverse relationship.
Read: Stock market may look calm lately, but volatility remains a threat in 2018
Earlier this year, when volatility spiked and the S&P 500