“The markets are crazier than ever.” We’ve all heard it, read it, or at least considered it ourselves. Are they though? Or has a lack of volatility over the last decade lulled us into thinking that the 10% annualized gains that the stock market provides us over the long run come without a cost of, at times, stomach-churning volatility.
While it certainly seems like markets are crazier than ever, could this simply just be a product of the constant barrage of a twenty-four-hour news cycle, coupled with the huge decline in informational boundaries that has allowed us quicker access to market prices, movements, data, and news?
Humans are hardwired to put outsized emphasis on the experiences that are freshest in our minds. Psychologists refer to this as recency bias – and it can be hazardous when it comes to investing. We naturally expect negative recent events to persist, which can cause us to make irrational decisions, such as chasing popular investment trends or bailing out of equities near market bottoms. These short-term decisions can have significant negative long-term effects on our financial plans. As investors, we must constantly ask ourselves – are the markets really crazier and more volatile than ever, or are our natural human behavioral biases clouding the fact that recent market events are part of a long string of uncertainty that stretches back almost 100 years?
The data confirms that while markets are certainly more volatile than in recent years, maybe all this means is that after a period of aberrational tranquility, markets are finally normal. Let’s take a look at a few charts that show that not only is the current bout of volatility not out of the ordinary, it is entirely within the confines of historical probabilities, and should be fully expected and embraced. After all, volatility is the very reason that stocks provide a higher return than bonds over the long run. The only reason we are rewarded with a return is because we choose to take a risk.
Magnitude of the Daily Change in the S&P 500
While Covid gave us the largest spike in volatility since the Great Depression, we have settled back into what is a fairly normal average daily return. This chart takes the average of the magnitude of the daily change in the S&P 500 over the prior 30 days. As of the end of February, the average absolute 30-day daily return for 2022 sat at 0.92%, just above the long-term average of 0.76%.
Average Volatility Over the Prior 30 Days
The rolling 30-day standard deviation of the S&P 500 tells a similar story. The lowest volatility in over 50 years preceded the massive Covid spike. The rolling 30-day standard deviation of the S&P 500 has settled down into what are historically normal levels.
Daily Moves +/- 2%
Even with the markets dropping 30%+ in a month during early Covid, 2020 was still well below the Global Financial Crisis and didn’t even come close to the Great Depression in terms of daily moves of more than 2%.
Maximum Drawdowns by Year
The markets rise and fall, and in any given year the market should be expected to correct around 16% according to historical averages. Although 2022 has gotten off to a rocky start, this drawdown is well within the range of historical probabilities.
And let’s remember, volatility isn’t something that we should try to avoid, as volatility often sows the seeds for outsized future returns. One of the most common gauges of volatility in the last 30 years has been the CBOE Volatility Index, commonly known as the VIX. You’ll notice that large spikes in the VIX are often followed by above-average returns.
We hear it all the time – “What should we be doing right now with all of this uncertainty?” And our answer is this – embrace it. For a market without uncertainty is a market without risk, and a market without risk is a market without return. Over the long run, the market has climbed a huge wall of uncertainty, and we have no reason to believe that high inflation, the geopolitical catastrophe in Ukraine, or the prospect of higher interest rates should interrupt this trend.
This will be the first part of a two-part series on market volatility. In part two, we’ll look at how tightening financial conditions affect market volatility, as the Fed ends its bond-buying program and prepares to raise interest rates at March’s FOMC meeting.
If you are a Legacy client and have questions, please do not hesitate to contact your Legacy advisor. If you are not a Legacy client and are interested in learning more about our approach to personalized wealth management, please contact us at 920.967.5020 or firstname.lastname@example.org.
Connor R. O’Brien
Trust Investment Officer