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Putting Recent Volatility into Historical Perspective(Guest Commentary By Bill Rempel – April 3, 2008) Dear Subscribers and Readers, For those who had wanted to learn more about individual stocks, the art of stock selection, and model-based trading/investing, it is again time to see what one of our regular guest commentators, Bill Rempel, has to say. Bill is a prolific writing on the stock market and individual stocks and is the author of a very active market blog at: http://billrempel.com (“The Rempel Report”). In this commentary, Bill is going to put the current volatility in the stock market (namely the Dow Industrials and the S&P 500) in historical perspective – as well as discuss the predictive value of such volatility. There are many charts and statistics in this commentary, but I assure you that this would be a worthwhile read. Without further ado, following is a biography of Bill: Bill Rempel (aka nodoodahs) is an active poster on the MarketThoughts forum as well as a few others around the web. Bill is a regular, monthly guest commentator on our website (see “Selecting Municipalities for Investment” for his last guest commentary). Bill graduated from Caddo Magnet High School (a high school for nerds) back in 1985 and proceeded to learn the hard way when he drank his way out of a scholarship to Tulane later that year. After a few years of sweating for a living, he decided to go back to school, and graduated from LSU-Shreveport in 1995 with a Bachelors in Mathematics - all the while working the overnight shift stocking shelves in a grocery store. Disclaimer: This commentary is solely meant for education purposes and is not intended as investment advice. Please note that the opinions expressed in this commentary are those of the individual author and do not necessarily represent the opinion of MarketThoughts LLC or its management. I don't know about y'all, but I haven't been able to read much market commentary without coming across somebody talking about how VOLATILE the markets have been in 2008. Like, it's a shock! Oooh, markets are volatile! Scary! It made me wonder just how the recent action stacks up on a historical basis, and I decided to share that research today. There are just a couple of definitions I need to present before I dive in; it's a bit chart- and table-heavy, so this will help.
Now that the definitions are out of the way, it's time to charge into the analysis. During the year ending March 31 of 2008 (YrEnd1Q 2008), the S&P 500 had an average daily percentage standard deviation (DailyStDev) of 1.20%, and the percentage of days where the index moved 2% or more in either direction (2%Days) was 11.16%. For the Dow Jones Industrials, these numbers were 1.10% and 9.20%, reflecting the fact that crisis was in financial stocks, which are light in the Dow. How does this compare to previous years?
In the history I have for the S&P 500, going back to 1950, the most recent year ranked 8th. Fairly impressive. But in the history of the Dow from 1901, it's nowhere near as impressive.
There were 29 other years with higher daily percentage standard deviations, and most of them had a much higher percentage of days with 2% moves in either direction. Would you have hated, or loved, to trade in the early 1930s? Would you have checked your account every 15 minutes online (if you could have, back then)? Because of its longer history, I will focus on the Dow Industrials, but the DailyStDev and 2%Days in the Dow and S&P (during the period when they both existed) have R-Squareds of 96.3% and 94.5% to each other (Aggie Stat Notes), so they're very comparable.
It's also pretty plain to see that the two measures of volatility are fairly equivalent. Indeed, the R-Squared between DailyStDev and 2%Days is 93.9% for the Dow since 1901, and 87.8% for the S&P 500 since 1950. The upshot of this analysis is that the volatility we've just seen, over the last 12 months, isn't really all that bad, comparatively speaking. It looks bad only because we don't have a good historical perspective. There is also some truth to the platitude that "bear markets are chaotic," because if we define a bear market as a period where the EZ Trend is DOWN, we can see that there's a negative correlation, not especially strong, between the EZ Trend and the volatility of the market. Years in which the majority of the time had EZ Trend UP tend to have fewer extremes of daily price swings, and vice versa.
Although that fact can give us comfort; that the volatility increases when EZ Trend is down, it's not really predictive of anything. Can a recently-passed year of high or low volatility tell us something about the returns for next year?
Um, nope. Not even for the more recent period covered by the S&P 500?
Nah. Regardless of what the permabears may say about the recent volatility, it ain't the harbinger of doom or Hell on Earth, it's just … volatility. To recap:
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