Market Matters: The Volatility of Volatility

October 21, 2014

 

Below is a weekly update from our Chief Investment Officer, Dr. Scott Lummer. He co-hosts an audio segment entitled “Market Matters.”  In this week's show, Scott discusses the recent uptick in stock market volatility, and whether it is truly unusual.  He also discusses how likely it is that the increase will persist. 

 

Episode Transcript:

 

Daphne:  Welcome to Market Matters, a weekly discussion about investing in today’s capital markets.  I’m Daphne Feng and as always, I’m joined by the Chief Investment Officer of Savant Investment Group, Dr. Scott Lummer. This week we’re going to talk about the recent volatility in the market. Scott, why has the market been more volatile lately? 

 

Scott:  As is often the case with modest increases in volatility, there is not one big reason, but several reasons in combination.  There is concern about interest rates in the U.S., growth in the worldwide economy, and the upcoming corporate earnings announcements.  And, volatility can be contagious – a large stock price movement in one day is likely to make investors anxious, and cause more volatility in succeeding days. 

 

Daphne:  You said this is a modest increase in volatility, but this seems to be the big story in the financial press.  Isn’t the increase more than modest?  

 

Scott:  That depends.  Do you think when it rains in San Francisco, it’s indicative of a huge change in the weather pattern, sufficient for front page news? 

 

Daphne:  No – it often rains in San Francisco. 

 

Scott:  You’re right – it rains about one in every five days in San Francisco.

And looking at the data over the past 40 years, the market has been as volatile as it currently is, or higher, 20% of the time.  

 

Daphne:  So it’s not that unusual an event. 

 

Scott:  Not at all.  In fact, we had almost the same type of experience in January and February of this year.  Stocks had this level of volatility, the market fell in value by 6%, and pundits started writing that the sky was falling.  But of course, the market recovered, increasing in value by 14% until September.  I’ll also point out that in terms of pure valuation, the overall effect of this so called calamity is relatively minor.  As we sit here on the morning of October 21, the market’s down only 3% from the beginning of the month.  That’s hardly the large market correction that pundits have been worrying about. 

 

Daphne:  Are you saying that the market will calm down soon? 

 

Scott:  I can’t say for certain.  All I can say is in most cases it does.  The causes of persistent increases in volatility are typically bigger events – the financial crisis of 2008, the internet bubble of 2000, the oil crisis of 1973. Also, other factors tend to contribute to the increase in volatility, such as high interest rates and above average valuations for stocks.  Currently interest rates remain low, and market valuation ratios are slightly below their long-term average. 

 

Daphne:  Should investors do anything in reaction to this volatility? 

 

Scott:  Not at this time.  The worst thing to do is to sell stocks in a panic. However, as I said, market movements like this occur relatively frequently. If the recent shocks have made you nervous, after markets have stabilized, you might want to consider reducing your long-term allocation to equities, and put a bit more in bonds. 

 

Daphne:  Why has there been so much attention in the press about market volatility? 

 

Scott:  Good question.  Why has there been wall-to-wall coverage of the threat of a so-called outbreak in the U.S. of a virus that has had a total of one transmission?  Panic sells.  To be fair, one reason volatility has gotten some attention is that as investors, we’ve been spoiled – that last three years have been relatively calm.  And just like worries about a virus, a little attention is a good thing, because it makes us more prepared.  But we’ve seen far too much of this good thing. 

 

Daphne:  Should our clients stop reading the financial press? 

 

Scott:  Definitely not.  We prefer to have informed clients.  But when getting information, I always want to know the incentives of the providers of that information.  The press has an incentive to make things seem unusual, so we’ll continue to read.  As long as we know that going in, we’re likely to not overreact. 

 

Daphne:  That’s Market Matters for this week.  Thanks to all of you for listening.  Please join us next week Scott and I will talk about specific end-of-year investment strategies. 
 

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