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.
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.