Some Analysts See Volatility Giving Way to a Rising Market

Everybody knows the stock market has been swinging wildly.

But depending on the yardstick you use, the recent volatility has been either downright historic--or historically not very significant.

More important, some Wall Street pros are making the case that, if volatility is indeed at extreme levels, it’s more likely to give way to healthy market gains over the next year than heavy new losses.

How extraordinary have the market’s recent swings been, in context?

One simple gauge of volatility is to take the market’s high price for the year, subtract the low price for the year, and divide the difference by the low price.

By that measure, the Dow Jones industrial average has swung by 23.9% so far this year.

That may seem high, but it’s actually below the annual swings of 1995 through 1997 (36.1%, 30.3% and 29.2%, respectively).

How can that be? In each of those three years, the market rocketed higher--the type of volatility that few investors complain about.

By other measures, however, the market appears significantly more volatile lately on a day-to-day basis.

Richard Eakle, head of Eakle Associates in Fair Haven, N.J., and a veteran market analyst, notes that the New York Stock Exchange’s first-tier trading curbs--which restrict certain computerized trading when the Dow moves more than 50 points up or down--have kicked in 240 times so far this year.

That’s far more than the 190 times the curbs kicked in by this time last year, he says.

Intuitively, many investors would probably say the market has been vastly more volatile, and Eakle agrees. “The equity market has become much more commoditized” over the last two years, he says--meaning, prices on a short-term basis have experienced the kind of dramatic swings more common in trading of commodities such as corn or crude oil.

A hedge fund manager, Eakle says that in his hunt for securities to either bet with, or against, “we’ve been finding many stocks [this year] that move up or down 20% in a matter of hours or a couple of days. That is unprecedented.”

Jeffrey Applegate, chief market strategist at brokerage Lehman Bros. in New York, likewise believes that market volatility has become extreme.

Since blue-chip stocks peaked July 17, the Dow has experienced 100-point-plus moves in 17 of 42 trading sessions, or more than 40% of the time. (Even at its peak of 9,337.97, 100 Dow points was meaningful--a 1% move.)

Even more striking is the market’s volatility as measured by its standard deviation, or the variation of its price moves relative to historical norms.

Applegate calculates that the blue-chip Standard & Poor’s 500-stock index’s variance over the last 12 months is the highest since at least 1950, with the exception of the horrendous 1973-’74 bear market and the 1987 market crash period.

“Volatility,” Applegate notes, “is another way to look at risk--it’s [a measure of] the riskiness of the returns” earned on stocks.

His explanation for the surge in volatility, and in particular the market’s plunge in August, isrooted in the fundamentals.

“Everything that could go wrong, did go wrong” over the last few months, Applegate says--Japan’s woes, Southeast Asia’s continuing economic collapse, Russia’s ruble debacle and the spread of that virus to Latin America.

All of that has raised major questions about the outlook for U.S. corporate profits and the U.S. economy in general.

But looking back at other periods of extreme stock volatility, Applegate says they usually give way to a rising market--not a flat or falling market. That was true, he says, following volatility peaks in 1963, 1974, 1984, 1987 and 1991.

The implicit assumption, of course, is that we’ve seen the volatility peak in this downturn--in other words, that the fundamentals, and the market, don’t deteriorate further.

Or as Applegate puts it, “If the world isn’t coming to an end, volatility ought to come down from here, and stock returns ought to go up.”

Eakle agrees. “Volatility occurs at important inflection points in the market,” he says. “Usually, it means a great bottom.”