It Is a Euphemism

Published On: April 13, 2020

Written by: Ben Atwater and Matt Malick

In the world of investing, “volatility” means you’re losing money.  For example, commentators refer to a bad quarter, like this most recent quarter, which was the worst first quarter ever for stocks, as being a “volatile” quarter. 

It doesn’t work the other way around.  Nobody said the fourth quarter of 2017 was a “volatile” quarter, rather people said it was a “great” quarter for equities.  Even last week, the best week for the market since 1974, commentators called a “bounce,” “rebound,” “rally,” even a “new bull market.”

So, in investing parlance, volatility is a euphemism for losses, while observers tend to use more positive words for market advances. 

Therefore, volatility has a bad name, not least because it’s stressful. But volatility is necessary.  It keeps speculators and marginal players from being long-term investors, freeing-up bigger returns for those of us who stick to our investment discipline. 

Not only can we benefit from the long-term profit growth of our companies, but, as long-term investors, we can also benefit from the mistakes of others.  Forced liquidations and panic selling are good for us.

In a note on March 9^th called Facts & Figures, we shared with you some statistics from BlackRock, the world’s largest asset manager.  Today, we are going to share historical perspective on “volatility” from the world’s second largest asset manager, The Vanguard Group. 

• In a study of so-called “geopolitical sell-offs” since 1956, Vanguard found them to be short-lived.  Markets returned an average of 9.8% one year following the event.  Clearly, COVID-19 doesn’t neatly fit in this category, but it is an event with a limited duration and therefore potentially comparable. 
• Looking at asset returns from 1926 forward, playing it safe doesn’t pay – a 100% T-bill portfolio, when adjusted for inflation, is more likely than stocks to have a negative return.  At the same time, diversification does pay.  A 60% stock / 40% bond portfolio has 36% less volatility than a 100% stock portfolio. 
• Volatility is normal, not abnormal.  Since 1979, we have seen 13 corrections (declines of 10% or more) and 8 bear markets (declines of 20% or more lasting at least two months). 
• Market timing is futile.  The best and worst trading days happen close together.  Thirteen of the best twenty trading days occurred in years with negative annual returns.  Nine of the twenty worst trading days occurred in years with positive annual returns. 
• Investors must be long-term investors otherwise average annual returns are irrelevant.  Stocks returned between 8% and 10% in only 6 out of 94 years.  Even bonds have only returned between 3% to 7% in 28 of 94 years.  Think about that.  To get long-term average 8% stock returns, you must endure years where markets go down 20%, while enjoying years where stocks go up 20% – there is no smooth path.  Volatility comes with the territory. 

Markets have an incredible amount of information to process related to COVID-19 and its longer-term economic impact.  This will take time.  In our view, patience is the most important attribute an investor can possess in this environment.