Long-term investors should look beyond stock market volatility
- History shows that long-term investment success is more likely to be the result of a consistent approach.
- Selling when markets become turbulent can leave an investor on the sidelines when stocks settle.
- We think investors will be compensated over time for accepting periodic volatility.
One definition of volatile is “tending to rapid and extreme fluctuations.” While stocks can be volatile, especially in response to major domestic or world events, historical market data show that prices typically have returned to less volatile patterns over time. That can be good news for long-term investors.
The 2008 credit crisis led to considerable fear and uncertainty about the global economy, which in turn contributed to significant volatility in stock prices. Global stock markets plummeted when the crisis first took hold, recovered in 2009, stumbled in 2011 and then began a generally steady rise that has continued so far in 2013. But slow worldwide economic growth and the uncertainty caused by government policies and political turmoil still prompt many investors to look for ways to reduce risk.
When it comes to the stock market, volatility typically refers to the size and frequency of price movements. Volatility can be shown using standard deviation, a measure of the variance in the returns of a given security or market index. In general, higher volatility means a wider range of potential values for a security or index, and the possibility of sharp movements over short time periods – whether up or down.
The volatility in global markets in recent years has caused some to suggest we are in a more volatile period than at any point in recent decades – and perhaps the onset of a “new normal.” While history cannot predict where the market is headed, a review of market volatility over time can be helpful in assessing the current situation.
While history cannot predict where the market is headed, a review of market volatility over time can be helpful in assessing the current situation.
Volatility shows historical patterns
An analysis of market data beginning with the years just prior to the 1929 stock market crash shows that periods of volatile price movements have not been unusual. Volatility historically has increased sharply during times of major global events or economic disruption. It then gradually has declined to what might be considered more normal levels, often after the triggering issues are resolved.
The green line in the chart below shows the historical mean, or average, level of standard deviation – or volatility – in the stock market since 1926, as represented by the S&P 500 Index. The periods of increased volatility are the spikes above that line. The level of volatility and the length of time it stays above or below the average have varied widely in the market’s history.
Economic uncertainty around the world since 2008 has again induced higher volatility into the stock market as a whole. One indicator of the increase in volatility can be seen in the table below, which shows the number of days when the stock market finished more than 2% higher or lower, based on the S&P 500 Index.
Stock market volatility in the 1990s generally was lower than average overall. But that period followed a highly volatile era that began in the mid-1980s. It included the “Black Monday” crash of Oct. 19, 1987, when the S&P 500 Index fell more than 20% in one day. A global stock market decline followed, and most major exchanges had declined by a similar amount by the end of that month.
A review of the period from 2000 through mid-2013 shows that more than one-half of the stock market’s “up” and “down” days have been recorded since 2008. There was a similar increase in volatility early in that time period, which coincided with the end of the dot-com bubble, the terrorist attacks of 9/11 and the onset of the Iraq War.
But the market recorded much lower levels of volatility in 2003 through 2007, throughout 2012 and so far this year. In fact, the three years of 2004-2006 had only two days when the market was up 2% or more and there were no declines of that magnitude. All in all, it was a period of unusually low volatility in stocks.
Perception affects strategy…and results
In his 1992 book Market Volatility, Yale University economics professor Robert J. Shiller took on the subject of price volatility. Shiller used statistical evidence to analyze whether price movements were the result of fundamental economic factors, or whether they were due to “changes in opinion or psychology” among investors. He wrote that economic value accounts for some aspect of price, but “…investor attitudes are of great importance in determining the course of prices of speculative assets. Prices change in substantial measure because the investing public en masse capriciously changes its mind.”
The sharp moves up and down in today’s markets can challenge even the most seasoned investors. When economic news or the market’s volatility becomes sufficiently unsettling, many investors decide to step to the sidelines and hope to “time” their re-entry to an improvement in market conditions.
But there’s a problem with that strategy: It is not possible to accurately predict the exact timing of market moves. History shows that long-term investment success is more likely to be the result of a consistent approach, based on time in the market – not market timing. Attempts to time the market also can lead to buying high and selling low, which is the opposite of a successful investing strategy.
Selling when markets decline or become turbulent can leave an investor on the sidelines when stocks change direction – which can happen quickly. For example, the S&P 500 Index made a one-day gain of 11.6% on Oct. 13, 2008, after eight straight sessions of falling prices.
The charts below make it clear that, even in volatile markets, missing just a few of the stock market’s best single-day performances could have a significant effect on your portfolio. While the effect on returns of the S&P 500 Index in the last 20 years is noteworthy, for example, it is even more compelling in just the past 10 years. Only a fully invested portfolio would have produced a significant positive return during that period.
In fact, some financial planners have noted that investors who move out of stocks during volatile markets may be trading one perceived risk for another form of risk. For example, holding cash in an attempt to avoid stock market volatility could raise the potential for missing longer term investment goals, as the real rate of return on cash currently is negative once the impact of inflation is calculated.
Looking beyond current markets
Increases in stock market volatility have been the norm in periods of uncertainty or as a result of major events for more than 85 years. When the outcome of such ”shocks to the system” become more clear or the events are fully resolved, investor confidence tends to rise and volatility tends to decrease to the historical mean. In the long term, stock investors generally have been rewarded for patience and consistency, as shown in the chart below.
Although periods of volatility may be unnerving for individual investors, an experienced investment management team can distinguish between daily market noise and real long-term risks to position a portfolio accordingly. At the Ivy Funds, we think investors will be compensated over time for accepting periodic volatility in the current market environment.
Past performance is no guarantee of future results.The opinions expressed in this article are those of the Ivy Funds and are not meant to predict or project the future performance of any investment product. The opinions are current through Sept. 15, 2013, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.
Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. For a prospectus, or if available, a summary prospectus, containing this and other information for the Ivy Funds, call your financial advisor or visit www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.
Ivy Funds are managed by Ivy Investment Management Company and distributed by its subsidiary, Ivy Funds Distributor, Inc.