I’m hearing several comments along the lines of ‘oh my gosh, the markets are so volatile!’
Yes, these 1%+ daily moves seem pretty crazy. I mean, how normal is that?? Two approaches, to my mind:
- Stats time: the long term (since 1950) annualised volatility of S&P500 returns is around 15.6% (data source: Quandl). Assuming 260 trading days/year, and roughly normal distribution of daily returns, a 1% daily move is just outside 1 standard deviation. That infers around a 30% probability of any given day being + or – 1%. Yesterday’s 2% move? That’s getting into the tails of the distribution: on any given day, there’s around a 5% chance of a + or – 2% move. If we further assume daily independence of returns (a very dubious assumption, but one frequently made), the chance of the past 2 days occurring in sequence (1.8% move followed by 2%) is around (5%)^2, or about 0.25%. That means we should expect this event roughly once a year. Again, note the dubious assumptions.
- Picture time: though the long term volatility in the S&P is around 15.6%, a shorter-term measure of volatility (30 days, exponentially-weighted) shows market behaviour has been decidedly less volatile in recent years. A previous post remarked on this using drawdowns. Note that, even with the recent pickup in extreme movements, we’re still a long way from the high-vol days of previous decades. In fact, our current volatility is about average – 15.9%.
Note for those paying close attention to my previous posts, and thinking portfolio management-wise: equities are notorious for a ‘double-whammy’ – higher volatility when returns are particularly negative. It’s as if long-only investors double down as markets fall. What to do? Well, just keep in mind that $100 invested in equities today may perform like $200 if markets really sell off – either buckle up, move to cash, or get diversified.