Like it or not, stocks are volatile. Not just now but often.
There’s no doubt that volatility has picked up meaningfully during the last 6 weeks or so. These more dramatic moves up and down in stock prices can be tough to take for some investors especially, of course, when there are more downs than ups like we’ve had!
The more difficult reality for some investors to accept though is the fact that the last 6 weeks’ ups and downs are actually far closer to normal market behavior than we had become accustomed to. This fact is clearly illustrated in the accompanying graph of the volatility of the S&P 500 from 1950 through today.
Source: www.YahooFinance.com ; Patton analysis
The blue line in the graph is the current volatility of the S&P 500 and the green line represents the average during the entire period. Of course, by definition volatility is above average about ½ the time so it is seldom “average”. Today, on the far right side of the graph, the current volatility level is just slightly above the long-term average.
There have been a handful of spikes in volatility as highlighted on the above graph. When we zoom in on the years of the current bull market that began in March 2009, we can see that we’ve spent a significant amount of that time with below average volatility. In particular, 2017 was about as good as it gets with volatility staying very low for a considerable stretch of time. That wasn’t normal!
We’ve certainly seen more volatility in 2018. Stocks got off to a hot start in January, which was technically volatile but the kind of volatility we all like…UPSIDE volatility! This was then followed by a quick and sharp decline followed then by a period of far below average volatility. At the start of October volatility was back down to about half its average and has since moved higher but now just marginally above average.
The fact is that data suggests that today’s volatility is far closer to normal than what most investors would like to believe. Volatility is the price we must pay to achieve the great long-term returns delivered by stocks. Get used to it again!
Some math about volatility
Is a 200 point gain or loss in the Dow Jones Industrial Average normal today? Statistically speaking…yes.
The long-term volatility of the market says that in approximately 1 in every 3 days the Dow will gain or lose more than 220 points (statistically a move of +/- >= 0.89% or more). Furthermore, in 1 in every 20 days there will be a gain or loss of more than 440 points (+/- >= 1.78% or more). What seem to be sometimes be big moves are actually very much to be expected and very normal.
One of the challenges for investors and the reality about this math is that these bigger market moves often come in bunches. That’s the definition of a more volatile market environment. For example, in 2017 when volatility was very low, we would have expected 84 of 251 trading days during the year to have a move greater than +/- 0.89%. But, as the table shows, there were only 12. Compare this then to 2018 when volatility has jumped above average twice, there have been 16 days when the market moved more than +/- 1.78% and statistically we would have expected on 11. Of these 16 bigger moves in 2018, unfortunately 12 were down and only 4 were up. That’s the nature of a market in a correction!
When we talk about such things as average volatility, these averages tend to be based on longer periods of time. Shorter periods of time, sometimes even multiple years in a row, can lead us to believe things are different than they actually have been and likely will continue to be. I think that’s the case for volatility. We have had some long stretches of below average volatility and today we are just returning to something closer to normal.
Stocks are volatile. Expect it. Today’s volatility does not make stocks a bad investment. To minimize some of the volatility investors need to diversify their portfolio into multiple investments that do not always move up and down together such as our Super-Diversification investment strategy.