The Evolution of Stock Market Volatility – Motley Fool

This Article Was Originally From This Site

The past two months have been quite the wake-up call for investors who’ve become accustomed to the stock market’s so-called “melt-up.” After going two full years without so much as a blip in the uptrend, both the iconic Dow Jones Industrial Average (DJINDICES:^DJI) and broader-based S&P 500 (SNPINDEX:^GSPC) have logged some of the wildest trading action that Wall Street has seen since the Great Recession.

Both indexes recorded their biggest single-day point decline in history on Feb. 5, 2018, and also witnessed at least one single-day point gain that’s cracked the top 20 of all time. In fact, the S&P 500 took just 13 days to push from an all-time closing high to a 10% correction, representing the shortest peak-to-trough move in terms of calendar days in decades.

Image source: Getty Images.

Truth be told, though, the volatility that investors have experienced over the past two months is nothing like that of the Great Depression. When put into the proper context, our recent volatility is actually quite trivial.

Making sense of Great Depression-era volatility

The simple answer of why there’s such a difference in volatility between the Great Depression and today is access to data.

Back in the late 1920s and early 1930s, annual reports would be mailed to the homes of investors, with any major developments in publicly traded companies often showing up in the financial section of the newspaper a day or two later. For that matter, you often didn’t know where your equity holdings closed until you received the newspaper the following day.

Getting information also required a lot of time, with prospective investors having to do virtually all of the homework on their own. There weren’t any readily available resources to compare price-to-earnings ratios or any of the number of valuation metrics we hold near and dear today.

Image source: Getty Images.

But most importantly, nothing was automated. Traders on the floor of the New York Stock Exchange handled orders and balanced trading to the best of their ability. This, along with an abuse of margin (i.e., borrowed money) by risk-taking investors, is primarily attributable to the incredible volatility experienced during the Great Depression and in the years that followed. Within the S&P 500, 15 of the 20 largest single-day point gains occurred during the Great Depression, with more than half of its 20 single-day largest losses occurring during the Depression years as well.

It all boils down to data access

Fast-forward to 2018. Today, practically everything is automated and regulated to the “T.” We have access to financial statements dating back five or 10 years (maybe even longer), can easily compare how a publicly traded company’s financial metrics stack up against its biggest competitors, and are assured of getting access to information at the same time as Wall Street.

We also have complex trading algorithms and computers that are responsible for the bulk of trading volume. According to JPMorgan Chase, just an estimated 10% of trading volume is from regular stock picking. The remainder is related to quantitative and computer trading designed to skim fractions of a profit from a high volume of transactions. Keep in mind that these algorithms don’t always work perfectly. Computers have been responsible for a handful of “flash crashes” in the stock market since 2010.

Image source: Getty Images.

However, the key difference here is in access to data. With individual investors and Wall Street institutions having ready access to financial statements, balance sheets, broad economic data, and practically anything else you can dream of, it’s become easier than ever to keep a level head when the stock market declines.

For example, I’d propose that there have been significantly fewer bear markets as a result of an increased access to data. Between 1929 and 1949, there were 11 bear markets — i.e., at least a 20% decline from recent highs — in the S&P 500, according to data from Yardeni Research. Comparatively, following the launch of computer trading in the 1980s, and internet access for the public in the 1990s, we’ve witnessed just three bear markets over the past 35 years. The proof is in the pudding, and access to data has been the key.

So, what does this mean for investors? While we can’t accurately predict when corrections will occur, how long they’ll occur for, and how steep the drop will ultimately go, we can feel pretty good about the fact that our ease of access to data should help long-term investors remain calm and collected and in the process keep volatility to a minimum, at least compared to where it used to be in the 1920s and 1930s.

Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

This Article Was Originally From *This Site*