Economic expansions send more than stock prices soaring. Such periods of electrifying growth also stimulate our emotions. When things are going well in an expansion, life feels darn good. But when the market stumbles inside that same expansion, it can feel calamitous. This point is especially true of the remarkable economic “high” we’ve been on since our recovery from the Great Recession.
Things have not always been rosy during this expansion – the market has gone through pullbacks and outright corrections. But the first half of 2019 looked pretty good. Despite all of the handwringing over trade strife and a slowing global economy, the S&P 500 gained 17% during the first six months of 2019 – its best first half since 1997. Similarly, the Dow was up 14%, its best first half since 1999.
But, oh, the volatility. In the first half of 2019, the market’s occasional wild swings blew the roof off the building.
To get a sense of just how volatile things were, we turn to the Cboe Volatility Index or VIX Index. The VIX Index is a calculation aimed to quantify constant, 30-day expected volatility of the US stock market. The data underneath it is derived from real-time, mid-quote prices of S&P 500 Index (SPXSM) call and put options. Globally, it is one of the most recognized measures of volatility – widely reported as a daily market indicator by financial media and closely followed by market participants.
The VIX Index plummeted 41% in the first half of this year; the largest first-half decline we’ve seen since 1990! This figure was due, in part, to the fact the market was at an extreme high at the end of last year.
Some investors believe the market’s level of volatility can serve as an early warning sign that an expansion is nearing its end. I don’t believe that to be the case. Twice during the current expansion financial professionals have warned that a recession was imminent because of changes in the VIX – once when the index increased, once when it decreased. As you may have noticed, those were false alarms. Still, volatility does have its uses as a predictor of the economic cycle when considered as part of a broad range of indicators.
More concerning to me as a Certified Financial Planner is that volatility, and a lack of understanding of its meaning, can scare investors out of the market – potentially costing them future gains.
With all that in mind, let’s talk about volatility.
Volatility is not a new phenomenon. It has always been an integral part of the market. However, in recent years, the market’s swings have become more pronounced. Think back to the years before 1990. Markets were relatively steady – almost well-behaved – in the 10% range. Since 1990, however, the market has operated at more extreme levels.
Generally speaking, market volatility since about 1994 is on average with that of the last 100 years. The big difference, however, is that today we go through periods of extremely low volatility (about half of the time) followed by extremely high volatility – think in the 20% realm – relative to average historical volatility. Before 1990, we could get an orderly selloff. But today, they are more violent than they used to be, which leads me to wonder if this is the “new normal.”
What’s interesting about the most recent years of the current expansion is that the periods of calm are particularly serene, but when the market gets turbulent, we really feel it.
Maybe that’s because when stocks are flirting with records highs, many investors are hyper-vigilant about getting caught in a market drop and thus sell more quickly than investors in previous eras. The Federal Reserve’s interest rate decisions also play a role in volatility. Many folks believe that if the Fed lowers rates, stocks will likely rise over the short term. And, of course, there are political factors. Washington’s policies have a real impact on the economy, and any utterance that comes out of the White House can ripple all the way to Wall Street (Trade war, anyone?).
Still, when trying to get a sense of where we are in an economic cycle, there are a handful of factors to consider. Volatility is one source of frustration for today’s investor, but it’s not the only useful metric in deciding how much longer we have in a period of growth.
Arguably the most important indicator of market performance is earnings. The stock market’s direction is heavily influenced by the profits that companies generate and expect to generate, both individually and in aggregate. And, we always want to keep an eye on bull market run-ups from the rock bottom start to where they are today. As an example, the bull market that began in late 1990 until early 2000 didn’t end until after it had a 417% run-up.
Back to the present, what’s important to note is that investors still have faith; they’re continuing to put money in areas of the market that look relatively expensive. These people believe that companies whose prices carry a premium will be able to deliver above-average growth over the long-term.
Remember, we will go through periods, like during the current year, when things are calm. But, we have to be prepared as investors for the inevitable extremes of late. It is critical to understand and to fortify ourselves emotionally against this reality. Sure, the swings make it more tempting to try to time the market – higher extremes lead to more significant emotional swings, and you get tempted into the lion’s den of excessive trading.
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