February 7, 2018
When people say “volatility is back”, what they really mean is that downside volatility is back. Most people would not have called it “volatility” if the market was up 6.1% over 2 days at the beginning of this February, instead of down. At Plum Street Advisors, we try to maintain objectivity about volatility, whether it’s up or down, and mitigate (as much as possible) the emotional impact of dramatic newspaper headlines.
First, the recent levels of volatility are perfectly normal. Volatility has been extremely low until this past week. In the chart below, we indicate all of the daily changes in the S&P 500 (whether up or down) that were greater than 2%. Note that the recent daily declines of just over 2% on February 2nd and just over 4% on February 5th are not at all uncommon – in fact, they are entirely expected. It’s the lack of any +/- 2% moves in 2017 that was unusual.
Daily stock market changes of more than 2%: 1/1/1990 – 2/6/2018
Second, short-term volatility is basically meaningless for us long-term investors. Whether investors are jumping around or moving calmly, as long as the fundamental economy continues to grow, in the longer term the market will follow along. The following chart shows how the short-term “noise” eventually is overcome by this longer-term “signal”. While over a rolling one-year period, returns can swing quite wildly, over longer rolling periods, the stock market has been quite steady. The S&P 500 has never been negative over any rolling 20-year period back to its inception in 1926 – and that includes the period following the 1929 crash. The following chart shows how volatility decreases as you extend the period (analysis over the past 60 years):
S&P 500 Range of Returns over Various Rolling Periods (Annualized %): 1/1/1958-1/31/2018
Third, volatility can actually present opportunities for the patient long-term investor. Rebalancing portfolios can add value if prices jump around a long-term mean return as we buy assets that have recently underperformed and sell assets that have recently outperformed.
Volatility is a funny thing. The news media loves it because they can sell headlines about “record” point drops in the Dow (even when the percentage changes are much less impressive). Some investors are legitimately fearful of volatility because they have mistakenly invested in risky investments with money intended for short term goals. But, for those of us investing for the longer run, it’s just business as usual.