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July 01, 2014 at 07:10 AM
The stock market has been absolutely ebullient this year. The major indexes cruised to new all-time highs more times than one can count in 2014, and with minimal volatility.
The best way to measure how smooth the ride has been for investors is the Sharpe ratio. This metric divides the return less the risk-free rate by the standard deviation of a return stream. A large Sharpe ratio is indicative of a market that has delivered positive returns with relative small pullbacks. The result is the remarkable graph shown below.
What really strikes me is that, according to this measure, an investor has received nearly three units of return for every unit of risk. Even the most risk-managed strategies struggle to have a Sharpe ratio of 1. For an unmanaged equity index to be much above this number is really unusual.
