Commentary: Don't Sweat Those Market Swingsby
Watching the stock market send portfolio values on a roller-coaster ride has investors in a tizzy. Indeed, some market pros warn that increased volatility could be a sign of a downturn in the making. But while it is undeniably nerve-wracking, the market's recent pickup in volatility is neither very unusual--nor all that worrisome for long-term investors.
True, daily swings in the Dow Jones industrial average are greater now than they have been for years. As Edward M. Kerschner, chairman of PaineWebber Inc.'s investment policy committee, notes, the average of absolute daily price changes in the Dow since 1940 is 0.60%, and has been 0.68% since 1970. During 1997, the average is 0.83%. But "although we are above the historical average, we aren't approaching unprecedented levels," he says. "The current level is comparable to the volatility observed during much of the 1980s. This is truly not significant."
"BACK TO NORMAL." The pickup in the market's swings feels more drastic than it is. "One reason volatility is getting so much attention now is because it's back to normal," says Abby Joseph Cohen of Goldman, Sachs & Co. "We got used to a period of abnormally low volatility and abnormally high returns. Now, we have to get used to normal."
A jump in volatility doesn't shed light on what the market is likely to do next. Says Kerschner: "There's no correlation between absolute volatility and market direction. High volatility years don't necessarily produce high or low returns." Laszlo Birinyi of Birinyi Associates Inc. says volatility does seem to go up during corrective periods in the market, but it doesn't appear to tell investors much more than that. He notes that, during late 1989 and 1990, there was a lot of volatility, but it didn't lead to a downturn. In fact, the market was up 20% in the first half of 1990.
Therefore, the average investor doesn't have a solid reason to be worried about greater volatility. "We don't know if this is yet translatable into a volatility that would affect the horizons over which the average investor should be concerned," says Jeremy J. Siegel, the author of Stocks for the Long Run and a professor of finance at the Wharton School of the University of Pennsylvania. "It mostly plays itself out on a daily or even intraday basis." What's strange about today's market, he says, is that historically, the periods of highest volatility are usually found at market lows, not highs, and they usually precede a period of rising markets. Granted, the market did become more volatile at the top of the market in 1929, he notes, but there have been other peaks when there hasn't been an increase in volatility. "It's very hard to interpret," says Siegel.
There may be a simple explanation for the increase in volatility during the late summer. August is usually a time of thinner trading volume, so waves of program trading have a more pronounced effect. "Sometimes these 50-to-100-point swings have little to do with anything else but program trading," says Eric Miller, chief investment officer at Donaldson, Lufkin & Jenrette Securities Corp. Birinyi notes that the level of program trading in August was one of the highest in history.
While the overall stock market may not be experiencing an unusual level of volatility, some individual stocks are, notes Princeton University's Burton G. Malkiel, author of the influential book A Random Walk Down Wall Street. Take Micron Technology Inc., which fell about 10% after not meeting its earnings estimate on Sept. 23. This volatility matters, because fund managers are concerned about having to go in front of investment committees and explain why they bought a stock that has taken such a large tumble, says Malkiel. "It means that, to the extent that individual stocks are considered to be more volatile, there may be higher risk premiums attached to them," he says.
Volatility in individual stock prices shows that investors are absorbing and reacting to news far more quickly. Built into the prices of stocks, to a greater degree than ever, are earnings estimates and a host of other financial information--so when a target is missed or exceeded, the reaction is swift and strong. We will have to grow accustomed to larger swings in both individual stocks and in the market. And that in itself is not such a bad thing.