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- The media love to scare readers with shock-horror headlines about ‘volatility’ and ‘uncertainty’ about the future – but this is just mindless clickbait.
- We are not living in ‘volatile’ or ‘uncertain’ times any more than we were 10 or 20 or 30 or 100 years ago. When was the future ever ‘certain’ (except in hindsight)?
- A week before the 1929 crash, America’s leading economist (Irving Fisher) and numerous other ‘experts’ dismissed the possibility of a crash.
- Right up to the outbreak of the ‘Great War’, national leaders and captains of industry dismissed the idea that any nation would start a war as it would make no economic sense.
- A week before the Lehman bankruptcy, the company reported positives reserves and Wall Street dismissed the possibility of bankruptcy because the Fed had just set a precedent by bailing out Bear Stearns.
- A week before the Covid lockdowns, nobody could have imagined that governments everywhere would suddenly lock millions of citizens in their homes and out of their workplaces for months on end, or that within one month, countries everywhere would suffer their sharpest and deepest economic recessions since the 1930s Great Depression, or that governments would run up war-time-like deficits and debts, etc.
- In June 2021, the RBA undertook to keep cash rates at 0.1% for three years by pegging the 3-year bond yield at 0.1%, but suddenly ditched it less than three months later, and ended up hiking rates 13 times in the three years rates were supposed to be kept flat.
- Or for a good laugh on a slow day, just take a look at the Fed ‘dot plot’ charts for their own interest rate setting intentions, and compare them to what they actually did just a few months later. Pick any year.
- I constantly come across statements from so-called ‘experts’ proclaiming: ‘Investors are now facing a more volatile and more uncertain future! Problem is - The only certainty about the future is that it is completely and utrerly unknowable so, by definition, the future cannot somehow now be more uncertain!
- Today’s chart shows ASX volatility by decade since the 1920s, on three different measures of volatility.
- It shows that ASX volatility has actually been running at a fairly constant level since the 1980s, and the current 2020s decade is similar.
- This is despite endless ‘shock-horror’ headlines about Trump’s tariffs, Putin’s wars, the so-called ‘US dollar crisis’, escalating wars and military tensions around the world, and constant, tiresome warnings of imminent recessions and crashes.
- Long-term investors learn to ignore volatility, but it is still important for two main reasons - (a) for buying opportunities, and (b) for reinforcing focus on fundamentals when the media and everyone around us are panicking. Mindless frenzied buying, as well as mindless panic selling, always create opportunities.
Today’s chart shows daily volatility on the ASX per decade since 1920, using three different measures of volatility.
The upper section shows the average daily ‘Up move’ per decade (green bars) and the average daily ‘Down move’ per decade (red bars). Talking about market volatility in terms of ‘up moves and ‘down moves’ may sound a bit amateurish, but this is how ordinary investors like you and me think about volatility. If the market is down by say 5% today, then I can buy it (eg via a broad market ETF) for 5% less than I could yesterday.
We can see that decades with low volatility – like the 1930s and 1940s – had smaller average daily up moves and also smaller average daily down moves than other decades. Conversely, decades with higher volatility – like the 1980s and 2000s – had larger average daily up moves and also larger average daily down moves.
Today’s story is about average volatility per decade. However, if you want to see the actual short-term volatility spikes through various cycles, see -
Yet another way of looking at volatility is the number of ‘BIG’ days (defined by say 5% more) – I do this here:
‘Standard Deviation’
The preferred professional definition of ‘risk’ is price volatility expressed as a ‘standard deviation’. In the lower section of the chart I show the annualised standard deviation of daily moves per decade (orange bars).
(Ok, since you asked: the ‘annualised standard deviation’ of a return series is the square root of the sum of the squares of the arithmetic differences between the natural log of the return for each period and the natural log of the mean period return, multiplied by the square root of the number of measurement periods per year. See! That’s why I prefer to talk about volatility in terms of practical things like actual market moves.)
It is no surprise that decades with low volatility – like the 1930s and 1940s – not only had smaller average daily up moves and smaller average daily down moves, also had lower standard deviations.
Conversely, decades with higher volatility – like the 1980s and 2000s – not only had larger average daily up moves and larger average daily down moves, also had higher standard deviations.
Early decades
Volatility in the 1940s decade was low because share price movements were artificially suppressed by government-imposed wartime share price controls from February 1942 to the end of 1945. Company profits were also controlled in Australia. Each year, the federal government confiscated every penny of company profits in excess of the 1939 profit level and used the money to fund the war effort. Company floats and secondary capital raisings were banned.
These share market controls were aimed at limiting war profiteering and encouraging capital to be diverted away from shares and into government bonds to fund the war effort.
Volatility was also relatively low in the 1950s and 1960s. It was a period of high protection barriers, heavy regulation of money and credit, and ‘financial repression’ (controlling interest rates to keep government borrowing costs down – as Trump is trying to do now with the Fed in the US).
Share market volatility rose in the 1970s with the 1970-1 collapse of the late 1960s mining boom, followed by the 1973-4 collapse of the property/finance boom, plus the problems of stagflation (high inflation and slow economic growth), and domestic political turmoil.
New era from the 1980s
From the 1980s onward, share market volatility has been running at more or less flat rate, higher than prior decades. Greater volatility was the combined direct impacts of several one-off changes – financial deregulation, globalisation of capital markets, floating of the dollar, computerisation of markets and investing, and a dramatic rise in the speed and volume of communications.
Since deregulation, globalisation, and computerisation, trillions of dollars slosh around the world in nano-seconds in search for returns, and it flees just as quickly at the first sign of negative news or rumour.
There have also been several additional developments that probably indirectly increased share market volatility – including the rise of derivatives markets, the rise of ‘algo’ and HFT trading, and the reduction in inflation (central bank independence) and therefore interest rates. However the overall levels of volatility have not risen since the 1980s.
Is volatility on the rise?
Demonstrably not. The 2010s promised to be a decade of high volatility, with a host of major crises, including -
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- the European sovereign debt crisis - Greek debt restructures, and numerous other national debt crises around the world,
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- the US credit downgrade crisis and debt ceiling crises,
- Trump’s first term and his failed but violent attempt to remain in the White House,
- China’s slowdown, which triggered a global commodities collapse that resulted in a collapse in aggregate ASX profits and dividends, and also a global and local oil / gas / steel bankruptcy crisis.
- Brexit, and Russia’s invasion and annexation of Crimea from Ukraine.
- a significant rise in populism, nationalism, civil and political unrest and violence around the world, stemming from globalisation, immigration, the casualisation and ‘uberization’ of jobs, and the GFC,
Through all of this, the 2010s turned out to be a relatively calm decade on the ASX (and in the US as well). It was the lowest average volatility decade since the 1960s.
2020s so far
The current decade has certainly had a good assortment of dramas and traumas so far, including:
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- a once in a century global pandemic where governments everywhere unilaterally locked up millions of their citizens in their homes and out of their businesses and workplaces for months on end,
- governments here and everywhere running up deficits and debts not seen since the 1940s,
- governments here and everywhere experimenting (and failing) with unprecedented monetary expansion,
- a once in lifetime inflation spike (duh!),
- aggressive interest rate hikes not seen in decades,
- new and widening war in Europe,
- new and widening wars in the Middle East,
- a new ‘cold war’ with the rise of a new global military and economic power (China) challenging the US.
Through all of this, overall ASX volatility is running at similar levels as in the last four decades.
Sure, we may (or probably will) have another major crash like the 1929-32 crash, or the 1987 crash, or the GFC, or the 1973-4 crash, etc, but all of those devastating crashes are already included in the chart. The market will probably take the next big crash (and the next, and the next) in its stride and recover (eventually) just like it has in past cycles.
What is ‘risk’ anyway?
Risk is probably the most important aspect of investing. Unfortunately, the finance textbook definition of investment ‘risk’ is temporary price volatility expressed as a ‘standard deviation’.
Of course you and I know that this temporary price volatility is certainly not ‘risk’ as we know it. For actual investors in the real world, financial ‘risk’ means things like:
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- the risk of running of money before we die,
- the risk of not reaching a capital or income goal,
- the risk of permanent loss of capital when an investment goes to zero,
- the risk of fraud,
- the risk of our money not keeping pace with inflation,
- the risk of loss if our bank or broker account is hacked or stolen, etc.
Each of these is much more serious and potentially damaging to wealth than temporary price volatility, which long-term investors learn to ignore.
But let’s go with the textbook definition of investment ‘risk’ as temporary price volatility expressed as the standard deviation.
High risk – high reward?
The 1980s was the most ‘volatile’ decade on the ASX (orange bars in lower section of the chart), but the 1980s was also the decade of highest price index returns (green bars in lower section). Higher ‘risk’ (higher volatility) was rewarded with higher returns. (Note that I am using nominal price returns here because that is what the volatility calculations are based on, not total returns, nor real returns after inflation.)
On the other hand, high volatility did not reward investors with higher returns in the 1970s or 1930s.
Why is volatility important for long-term investors?
Share market volatility is certainly of great interest and importance to day traders, high frequency prop traders, derivatives traders, and hedge funds. But I and my readers are not any of these, we are long term investors. So why is volatility important for us?
Two reasons.
First - as a long term investor I focus primarily on underlying fundamental value underpinned by cash flows, profits, and dividends, rather than daily price volatility. However, price volatility is very useful and important in providing buying opportunities, which can be quite rare. The greater the volatility, the better the buying.
Just like the old saying in real estate – ‘You make your money when you buy.’
Second - unfortunately, the downside of market volatility is that it scares many investors into making bad decisions at great cost to their long term wealth and living standards.
I have met investors who watched from the sidelines while markets ran hot in 2003, 2004, 3005, and 2006, then finally gathered up the courage to invest in 2007 (many were encouraged by the $1m Super contribution ‘window’ in 2007, and many even borrowed), and then they were promptly clobbered in the 2008-9 GFC crash.
I have met investors who so traumatised by the GFC they cashed out and retreated to bank term deposits for the next ten years. Then, when TD rates went zero in Covid, many were lured back into the share market by rising prices in the 2020-1 Covid stimulus boom, but promptly got clobbered once again in sharp sell-off in 2022 triggered by inflation and aggressive rate hikes. These are real investor clients of advisers I advise and mentor.
The difference between wealth and poverty in 20 or 30 years’ time is mostly about avoiding bad decisions, which usually comes in two forms – bad investments, and bad timing.
Learning to ignore volatility and ‘uncertainty’ and instead use it to advantage is a life-long journey. Every cycle is different in its own way, and certainly easier to understand in hindsight! I know I have made many mistakes over the years, but I am always learning!
‘Till next time. . . .safe investing!
Here is my recent story on volatility under Trump –
We have had some volatile times on the ASX – here are some articles on when they were and why –
Data for this chart:
- 1981 onward = Aust All Ordinaries
- 1958-81 = Sydney SX All Ordinaries
- 1938-1958 = Sydney SX Ordinaries
- Pre-1938 = custom large-cap index based on Sydney SX and daily prices