One of the biggest topics on the minds of financial services executives in 2011 has been volatility, with a slew of articles and TV news stories pinning the blame on high-frequency trading, hedge funds and leveraged ETFs.
For example, between Aug. 5 and Aug. 30, the S&P 500 Index averaged a 2.5% move up or down every day. However, careful data analysis actually proves that it’s the global macro environment—most recently the resurgence of the Eurozone debt crisis and the downgrade of U.S. Treasury bonds—that is driving this volatility.
This is according to a new report from Vanguard called, “August 2011 Stock Market Volatility: Extraordinary or ‘Ordinary?”.
Other recent factors that have sent the stock market gyrating include the prospect of a slowing global economy and “political brinksmanship in Washington, D.C.,” according to the authors, Francis M. Kinniry, Jr., Todd Schlanger and Christopher B. Philips.
“It can be difficult and potentially dangerous to cite causation, but many blamed the spike in volatility on a shift in market participants,” the Vanguard executives said. “However, if the increase in volatility were the result of these factors, we would also have expected to see a systemic upward shift in the volatility level over time.”
Vanguard looked at the reaction of the stock market to other major global macro events, such as the 2001 dot-com crash, the terrorist attacks of 9/11 and the financial crisis of 2008. Daily price movements in normal periods more than doubled during these global macro events, Vanguard research found.
“It is clear that periods of such volatility tend to cluster around these dislocations,” the researchers said. “As a result, we would argue that August’s volatility in equities—although high and painful to many investors—was not unexpected, given the market environment and the widespread repricing of risk.
“Thus, in Vanguard’s view, to cast the current environment as a ‘new paradigm’ of volatility is misleading. Going forward, it’s unknown whether the volatility will stay the same, increase or decrease,” Vanguard said. “What we do know is that previous periods of excess volatility have clustered around global macro events, and that portfolios that included allocations to less risky assets such as bonds and/or cash tended to ride out the storm much more smoothly.”
Volatility is part and parcel of the equity risk premium that investors seeking extra return must accept, Vanguard said. The asset management firm will update this report on volatility in January.
Lee Barney writes for Money Management Executive.
Register or login for access to this item and much more
All Financial Planning content is archived after seven days.
Community members receive:
- All recent and archived articles
- Conference offers and updates
- A full menu of enewsletter options
- Web seminars, white papers, ebooks
Already have an account? Log In
Don't have an account? Register for Free Unlimited Access