Market Volatility in Perspective

Sam Swift, CFA, CFP®, AIF®

May 15, 2020

If you’ve found yourself confused by the daily movements of the stock market, you’re not alone. In the face of COVID-19 and dire health news, we’re also seeing economic information you could mistake as a reprint from the 1930’s. Unemployment is officially around 15%, but most economists think the real number is closer to 20%. We are almost surely in the middle of a recession already, even if it hasn’t been officially declared. And yet, stock markets across the world have bounced back significantly from their panic-induced lows in March.

So what’s going on?

Let’s start by examining the heightened volatility we’ve seen lately. It’s helpful to think of volatility as the result of the conflict between short-term speculators and long-term investors. Take the 500-point upward swings that we’ve experienced several times. It’s bewildering on the surface when you consider the headlines on the front page, but let’s adopt the mindset of a short-term investor for a moment and assume we are trying to maximize our return by the end of this year. With that as the goal, then new information should be weighted heavily in our estimates. The difference from returning to some level of economic normalcy in June vs. July could have a pretty dramatic impact on a company’s bottom line for this year. Thus, in an environment where every day brings more significant news, we should see some big swings with short-term speculators changing their projections and bets dramatically.

Short Term vs. Long Term

Of course, not all market participants are short-term speculators trying to maximize return this year. Many of us are long-term investors. With a view of 10-plus years for our stock portfolio (and we’re all 10-plus year investors for the stock portion of our portfolio), does our expectation of long-term return change that dramatically whether the economy starts to open back up in June or July – or even 2020 vs. 2021 for that matter? Very likely no. At some point given increasingly bad news, speculators will drive the prices low enough where it starts to look very attractive to long-term investors who are more focused on longer-term outcomes. This is one of the reasons you can have large positive days in the midst of terrible news, and it’s likely one reason markets have rebounded off of the immediate short-term drop in early March.

Odds Are In Our Favor

I would add that being confused by daily market movements is not confined to times of heightened volatility. Daily market movements are random! Those who day trade may as well be sitting at the roulette table. But if day traders are equivalent to gamblers, then who are long-term investors in this analogy? That’s easy. We’re the house and we know the odds are in our favor given enough time.

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