Equities are more volatile now: Fisher's financial mythbusters


Sound like something you've heard? Investors don't just tend to focus mostly on shorter-term volatility, they fear volatility is increasing! And it may feel true. But don't believe it - it's a myth.

First, volatility is itself volatile. Second, it's a fallacy to assume higher volatility spells trouble. Third, volatility in recent years isn't all that unusual and is well within normal historical ranges.

To understand volatility, you must understand standard deviation. Standard deviation is just what it sounds like - a measure of how much something deviates from its average.

A low standard deviation means results didn't vary much from average. A higher standard deviation means there was more variability.


As of year-end 2015, the S&P 500's annualised standard deviation since 1926 was 15.4 per cent*.

But that includes the steeply volatile years of the two Great Depression bear markets, which drag the average up a bit. Since 1926, median standard deviation was 12.7 per cent (see exhibit 1 below, click to enlarge).


It's also important to remember that standard deviation is inherently backward-looking - it says nothing about what's ahead.

A standard deviation of 0 indicates returns have never varied - like cash (ignoring inflation). Equity market volatility is itself volatile: some years it's vastly above average, others it's below average.

What's more, equities can rise and fall on both above- and below-average volatility. There's no predictive pattern.

The most volatile year ever was 1932 with a standard deviation of 65.4 per cent**. But equities were down just 8.9 per cent for the year.

Not great, but not the disaster most would expect from monster volatility. Within the year, monthly returns were wildly variable - to be expected in the final year of the Great Depression's first down-leg.

The second most volatile year ever was 1933. Standard deviation was 53.9 per cent - but equities rose a massive 52.9 per cent***. Similarly, when standard deviation is around its long-term median (from 12 to 14 per cent), returns also vary hugely - both up and down.

So volatility isn't predictive. And it isn't trending higher, either. Look back at Exhibit 1.

See it another way: the Great Depression was wildly volatile up and down. Some folks think the Great Depression was one long bad period, but it was two recessions with a growth interval between, and two huge bear markets with a huge bull market between - history's second biggest.

Volatility then had myriad causes. One was a relative lack of liquidity and transparency - fewer equities, transactions and far fewer market participants. Information moved slowly, so price discovery was tough.

For all but the very largest equities, spreads between bid and ask prices were much greater as a percentage of the total price, so the bounce between someone hitting the bid or pushing on the ask moved transaction prices a wider percentage of the total price. Put all that together, and there is much more volatility.

Similarly, thinly traded markets even today are generally more volatile, like penny shares or emerging markets.

Because there are vastly more publicly traded equities now, vastly more participants, and information is easily and instantly available, markets should be inherently less volatile overall than in the thinly traded Great Depression days.


Much-maligned scapegoats for increased volatility are speculators. Speculators aren't bad, however. Holding shares for a long period indicates some speculation - they're going to do something, eventually. There's nothing wrong with that.

But that's not what people usually mean when they talk about speculators. They're typically referring to futures traders. A futures contract is an agreement to buy or sell something at an agreed-upon price at a future date: a bet on future price direction.

When oil prices rise sharply, headlines often blame speculators. But they don't realise speculators, as a group, don't work together: some will speculate prices will rise at the exact time others speculate prices will fall. Speculators can and do lose money - just like any investor.

Plus, there are myriad legitimate reasons to trade futures. Businesses use them to smooth costs. Farmers need futures for feed grain, fertiliser and fuel. 'Futures trader' doesn't conjure an image of Wood's American Gothic - but maybe it should.

Futures contracts and speculators play an important role in capital markets. They increase liquidity and transparency and speed price discovery. These are good things which can actually reduce volatility.

We can prove this with onions. In 1958, US onion farmers convinced Michigan congressman (later US president) Gerald Ford that speculators were wreaking havoc in onion markets and depressing prices. He sponsored a bill that became (and remains) law, banning speculation in onions.

Did it help? Not really. Exhibit 2 shows onion prices and oil prices. Just by looking, you can tell onions have much bigger and more frequent boom/busts.


Remember that the next time someone says the cure to the market's ills is banning speculators. Such a move may well increase volatility - along with reducing transparency and slowing price discovery.

So thank a speculator, and don't fear volatility. It's not predictive; and, over time, upside volatility happens more often. Embrace it.

*Source: Global Financial Data, Inc., as of 15/12/16, S&P 500 Total Return Index from 31/12/1925 to 31/12/2015.

**Source: Global Financial Data, Inc., as of 15/12/16, S&P 500 Total Return Index from 31/12/1931 to 31/12/1932.

***Source: Global Financial Data, Inc., as of 15/12/16, S&P 500 Total Return Index from 31/12/1932 to 31/12/1933.

Ken Fisher is founder and chairman of Fisher Investments.

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