Stocks’ Swings Are Wild, but Meaning Isn’t as Apparent
Ralph Bloch has been watching the stock market for more years than he cares to count, but even he has been stunned by the manic swings of the last four weeks.
The price chart of the Dow Jones industrial average “looks like a guy in the midst of a massive heart attack, or a lie detector test on someone who’s lying all over the place,” says Bloch, market analyst for brokerage Raymond James & Associates in St. Petersburg, Fla.
The seismograph needle’s swings during a substantial earthquake also come to mind.
The analogies are easy. What is harder for many investors to figure is whether this sudden bout of volatility is all that unusual, and whether it implies something more dire--like the imminent arrival of a bear market.
In fact, the stock price gyrations of the last month or so, including the Dow’s 171.24-point plunge on March 8 and the 110.55-point rebound in the next session, have only been the most visible signs of a market that is by all accounts becoming wilder in tone.
Yet everything is relative, as Einstein noted. Volatility is definitely rising compared with the market’s recent history. But then, stocks have been unusually un-volatile since 1992.
The Dow’s point moves aren’t a good gauge of volatility, because big point changes become much less significant, in percentage terms, as the index rises. So most analysts who track volatility instead watch the percentage changes in the blue-chip Standard & Poor’s 500-stock index.
In 1993 and 1994, the S&P; index’s annual volatility figures were the lowest for any years since World War II: a mere 9.3% and 9.4%, respectively. That percentage measures the difference between the index’s yearly high and low divided by the S&P;’s average price for the year--a way of expressing the percentage variation, up and down, from the average level.
Plenty of stocks rose or fell much more than the S&P; in both years, of course. But all in all, “the market” moved very little from start to finish, or in between.
In 1995 the S&P;’s volatility increased dramatically, but no one complained because the market was basically a one-way ticket: The S&P; rocketed 34.1% for the year, rarely pausing for breath in registering its best gain since 1958.
So here we are in 1996, and the S&P; has already ranged nearly 11%, up and down, from its average level year-to-date. That’s a bigger variation than in all of 1993 and 1994. But historically it’s not yet much to write the SEC about.
James Stack, editor of the InvesTech market newsletter in Whitefish, Mont., calculates that the average annual up-and-down range of the S&P; (from its yearly average) was 21.2% in the 1950s, 19.5% in the 1960s, 23.3% in the 1970s and 25.5% in the 1980s.
In other words, if you’re pining for a return to the “good old days” of a tame market, those good old days were in the early ‘90s. Even the market that Grandpa knew in the 1950s, before millions of shares could change hands in the blink of an eye, experienced more volatile price moves on an annual basis than what we’ve known lately.
Wall Street has offered many explanations for the lack of volatility in the blue-chip S&P; index in this decade, including that the constant and heavy inflow of cash into mutual funds has been a tide pushing stocks steadily higher.
Maybe. But so far this year, that tide of cash has been greater than ever, yet volatility (up and down) has returned. And by at least one widely followed predictor of market trends, the market’s manic swings are likely to continue.
The market volatility index, or VIX, created by the Chicago Board Options Exchange tracks “put” and “call” option prices on an index of 100 major S&P; stocks. Options are inexpensive ways for savvy investors to either bet on, or hedge against, market moves.
It would take half a page to explain exactly how the VIX works, but the basic idea is to use the trends in options to predict the potential for volatility up or down in the market as a whole.
The latest word from the VIX index is to strap on your safety belts: The index on March 8 reached 26.7%, its highest level since early 1991.
The VIX has since retreated, to 18.7% as of Friday, but that’s still a statement: Bernard Schaeffer, options expert at the Investment Research Institute in Cincinnati, says that at 18.7%, the VIX is essentially saying that “there is a two out of three chance that the [market] will trade plus or minus about 19%” in the near future from current levels.
That could, taken literally, mean a 19% plunge in the market. Which is what worries many analysts, who simply on a gut level believe that the uncertainty suggested by Wall Street’s mood swings this year bodes ill. “Increased volatility is often a precursor to a directional change in the market,” says Bloch.
As bearish investors have warned over and over, this bull market, now 5 1/2 years old, has yet to experience the sudden 15%-plus pullbacks that occurred regularly from the 1950s through the 1980s.
Even so, there is no rule that says a little extra volatility must spell the bull market’s demise. As Schaeffer notes, the VIX could just as easily be predicting a 19% surge in the market. And the VIX itself is hardly infallible. Often, it’s better at telling what the market is doing at a given moment than what it will do in the near future.
If volatility is back to stay, some market pros say it’s to be celebrated, not cursed. By definition, wilder short-term price swings mean that investors who focus on the long term get more opportunities to buy good stocks cheaper.
“Volatility allows me to take advantage of the emotion in the market,” says Jim Craig, manager of the $12.5-billion Janus Fund in Denver. “I personally love it.”
If Grandpa could handle volatility, we should be able to deal with it.
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Volatility, Ho!
The Chicago Board Options Exchange’s market volatility index-- created to predict the potential percentage magnitude of blue-chip stocks’ near-term swings, up or down --recently/ hit its highest level in nearly five years. Monthly closes for the index, and latest:
Friday: 18.7% (March, 1996)
Source: Bloomberg Business News
