The Markets September 14, 2011

Vanguard Research Finds August Market Volatility “Ordinary”

Vanguard researchers report that the levels of market variations today are ordinary when compared to other periods characterized by major global events.
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Their new research note “August 2011 Stock Market Volatility: Extraordinary or ‘Ordinary’?” finds that a spike in volatility in U.S. equities occurred during August relative to the preceding months. For example, from August 5 through August 30, the S&P 500 Index averaged a 2.5% move (up or down) every day. Such volatility represented a substantial increase over the periods immediately prior to the downgrade.

The report states many blamed the spike in volatility on a shift in market participants. However, if the increase in volatility were the result of these factors, we would also have expected to see a systematic upward shift in the volatility level over time, researchers said. Instead, volatility remained stable and low over the preceding months and instead spiked in conjunction with the emergence of significant global macro dislocations, capped by the downgrade of U.S. Treasury debt.

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Despite the downgrade, Treasury bonds rallied, returning 2.78% for the month of August as investors’ perception of future uncertainty and market risk increased, and a flight to quality ensued. Such a result, while surprising to some, has been common historically during periods characterized by significant global macro events.

The report authors note, although the stock market volatility appears extraordinary relative to the calm of the last year, the levels of market variations today are, in fact, “ordinary” relative to the volatility of other periods characterized by major global macro events. For example, from July 1992 through August 30, 2011, the S&P 500 Index averaged 0.70% per day in price movements. During those global macro events, however, the average daily price movements doubled to 1.46% per day.

The impact of the most recent environment on market volatility is at least on a par with that of previous market dislocations. It is clear that periods of such volatility tend to cluster around these dislocations. As a result, 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.

The authors note, whether one considers the recent period of market volatility extraordinary or simply ordinary—that is, compared to events of similar perceived gravity—the bottom line is that investors with balanced, diversified portfolios have faced much less aggregate volatility than the headlines would suggest. Going forward, it’s unknown whether the volatility will stay the same, increase, or decrease. What we do know is that previous periods of excess volatility have clustered around global macro events, and that, during those periods, portfolios that included allocations to less risky assets such as bonds and/or cash tended to ride out the storm much more smoothly.
The Markets September 14, 2011

U.S. Bond & Stock Mutual Funds See Net Outflows of $34B

In an unusually volatile month, nervous investors redeemed an estimated $34 billion in net cash out of U.S. stock and bond mutual funds in August.
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The S&P 500 index ended August down 5.4%, but experienced extreme declines and rebounds along the way, according to research from Strategic Insight, an Asset International company. Equity mutual funds saw a surge in net outflows in the second week of August, but then net outflows slowed to a pace more in line with recent months’ activity. 

“Our research over the past two decades shows that redemption spikes after stock market declines tend to be limited in scope and short-lived,” said Avi Nachmany, SI’s Director of Research. “However, continuing doubts about the U.S. economy and the European sovereign debt problems are reducing investors’ appetite for equity risk.”

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Equity mutual funds saw net outflows of $23 billion in August, compared with net outflows of $24 billion in July. U.S. equity mutual funds saw net outflows of $21.4 billion in August, and international/global equity funds saw net outflows of $1.4 billion.

Bond mutual funds saw net outflows of $11 billion, compared with net inflows of $8 billion in July. Taxable bond funds experiences net outflows of $10 billion, and muni bond funds experienced net outflows of $1 billion. Leading the way in net outflows were floating rate and high-yield bond funds, both of which are sensitive to fears of a recession. The bright spots were corporate short- and intermediary-maturity bond funds, which together took in $6 billion in positive flows as some investors continued to search for alternatives to low-yielding cash vehicles. 

“Bond funds’ net flows seemed to turn positive at the end of August,” said Nachmany. “Given the expectation of continued volatility and the Federal Reserve’s intention to keep interest rates extremely low, demand for select bond funds should rebound.”  

Money-market funds saw net inflows of $69 billion in August, benefiting from a flight to safety. That was a reversal from July, when money funds had net outflows of $113 billion. In the first eight months of 2011, money funds experienced total net outflows of $183 billion.

Separately, Strategic Insight said U.S. Exchange-Traded Funds (ETFs) in August experienced nearly $1 billion in net inflows. Leading the way in net inflows were large blend ETFs (nearly $5 billion in inflows), leveraged ETFs ($3 billion) and ultra-short maturity bond ETFs $2 billion); Diversified emerging markets ETFs saw the biggest net outflows (nearly $2 billion).

Through the first eight months of 2011, ETFs (including ETNs) saw net inflows of $89 billion, a pace that could still produce the fifth straight year of $100 billion or more in inflows to ETFs. At the end of August 2011, U.S. ETF assets stood at $1.06 trillion.

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