What you should know about stock market volatility (and how that might help you sleep better at night...) G. William Schwert October 3, 2013 Eisenberg Rotunda, 12:00-1:00 PM http://schwert.ssb.rochester.edu/gws_161003.pdf
From Presidential Debate, October 7, 2008
So What Was Candidate Obama Talking About? September 2008 unemployment rate was only 6.2% Up from 4.7% a year earlier, but much lower than many times in the prior 38 years On its face, this does not seem like the basis for making analogies to the Great Depression...
2006 2003 2000 1997 1994 1991 1988 1985 1982 1979 1976 1973 1970 12% 10% 8% 6% 4% 2% 0% Civilian Unemployment Rate, 1970-2008 Unemployment Rate
Stock Volatility Was Very High from mid- September through October 7 Date DJIA Change Pct Change Rank Sep-15 10917.51-504.48-4.42% 15 Sep-16 11059.02 141.51 1.30% Sep-17 10609.66-449.36-4.06% 17 Sep-18 11019.69 410.03 3.86% 16 Sep-19 11388.44 368.75 3.35% 26 Sep-22 11015.69-372.75-3.27% 35 Sep-23 10854.17-161.52-1.47% Sep-24 10825.17-29.00-0.27% Sep-25 11022.06 196.89 1.82% Sep-26 11143.13 121.07 1.10% Sep-29 10365.45-777.68-6.98% 1 Sep-30 10850.66 485.21 4.68% 9 Oct-01 10831.07-19.59-0.18% Oct-02 10482.85-348.22-3.22% Oct-03 10325.38-157.47-1.50% Oct-06 9955.50-369.88-3.58% 37 Oct-07 9447.11-508.39-5.11% 13 Red indicates among the 40 largest decreases of all time Green indicates among the 40 largest decreases of all time
What Is Market Volatility? Big changes in prices But, it turns out that it makes more sense to look at PERCENT CHANGES
1899 1901 1904 1906 1909 1911 1914 1916 1919 1921 1924 1926 1929 1932 1934 1937 1939 1942 1944 1947 1949 1952 1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 1,000 800 600 400 200 0-200 -400-600 -800-1,000 Daily Changes in the Dow Jones Industrial Average, 1899-2016 G. William Schwert, 2000-2016
How to Lie with Statistics Plot the Changes in the Dow This plot looks like a seismograph with an earthquake at the end This is why newspapers often write that recent days have had some of the largest changes in the Dow Jones Index in all of history...
Looking at the Percent Change of Stock Indexes Is Relevant... This measures the rate of return on the investment i.e., how many more dollars you would have at the end of the day if you invested $100 at the beginning of the day The following plot of daily percent changes in the Dow looks much more regular (and recent data do not look that unusual)
20% 15% 10% 5% 0% -5% -10% -15% -20% -25% 1899 1901 1904 1906 1909 1911 1914 1916 1919 1921 1924 1926 1929 1931 1934 1936 1939 1941 1944 1947 1949 1952 1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 Daily Returns to the Dow Jones Industrial Average, 1899-2016 G. William Schwert, 2000-2016
Standard Deviations of Returns Measure Dispersion How likely is it that we will see a big percent move in the Dow?
120% 100% 80% 60% 40% 20% 0% Annualized Standard Deviation of Returns 1899 1901 1904 1906 1908 1911 1913 1916 1919 1921 1924 1926 1929 1931 1934 1936 1939 1941 1944 1946 1949 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2004 2007 2010 2013 2016 Volatility of the Dow Jones Industrial Average, 1899-2016 G. William Schwert, 2000-2016
Another Way to Lie with Statistics -- Focus on Very Recent History Newspapers often focus on the last few years in discussing current conditions On this basis, people would think stock volatility was unbelievably high in 2008-2009 This is misleading when viewed from the perspective on the longer history we have available to us Compare the plots of rolling standard deviations from 2004-2016 versus the plot from 1897-2016 Good news is that things seem to have settled down a bit now (compared to 2008)
Volatility of the Dow Jones Industrial Average, 2004-2016 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Annualized Standard Deviation of Returns 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 G. William Schwert, 2010-2016
Similar Conclusions from Recent Intra-day Data: 15-minute Returns to the S&P 500 and S&P Futures These estimates of annualized volatility are independent from day-to-day Not overlapping Volatility was very high in late 2008, but now looks fairly normal Focusing on the post-2004 period is misleading
Volatility of the S&P 500 and S&P Futures, Based on Intraday 15-minute Returns, 1988-2016 9% S&P Futures S&P 8% Annualized Standard Deviation of Returns 7% 6% 5% 4% 3% 2% 1% 0% 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 (c) G. William Schwert, 2009-2016
Stylized Facts/Questions: A very long-term view! Market-level volatility has been remarkably stable over time Data back to 1802, covers many wars, financial crises, depressions/recessions Also, major changes in the composition of the US economy Mainly banks, insurance companies, canals in early 1800s Railroads started being important after 1834 Great Depression is the most notable period of prolonged high volatility
Annualized Standard Deviations of U.S. Stock Returns from Monthly Returns in the Year, 1802-2016 80% 70% 60% 50% 40% 30% Return Standard Deviation per Year 20% 10% 0% 2012 2007 2002 1997 1992 1987 1982 1977 1972 1967 1962 1957 1952 1947 1942 1937 1932 1927 1922 1917 1912 1907 1902 1897 1892 1887 1882 1877 1872 1867 1862 1857 1852 1847 1842 1837 1832 1827 1822 1817 1812 1807 1802 G. William Schwert, 2004-2016
Annualized Standard Deviations of U.S. Stock Returns from Monthly Returns in the Year, 1802-2016 80% Wars in Red 70% War of 1812 Mexican-American War Civil War Spanish-American War World War I World War II Korean War Viet Nam War Kuwait War Iraq-Afganistan War 60% 50% 40% 30% 20% Return Standard Deviation per Year 10% 0% 2012 2007 2002 1997 1992 1987 1982 1977 1972 1967 1962 1957 1952 1947 1942 1937 1932 1927 1922 1917 1912 1907 1902 1897 1892 1887 1882 1877 1872 1867 1862 1857 1852 1847 1842 1837 1832 1827 1822 1817 1812 1807 1802 G. William Schwert, 2004-2016
Annualized Standard Deviations of U.S. Stock Returns from Monthly Returns in the Year, 1802-2016 80% Recessions in Red 70% 60% 50% 40% 30% Return Standard Deviation per Year 20% 10% 0% 2012 2007 2002 1997 1992 1987 1982 1977 1972 1967 1962 1957 1952 1947 1942 1937 1932 1927 1922 1917 1912 1907 1902 1897 1892 1887 1882 1877 1872 1867 1862 1857 1852 1847 1842 1837 1832 1827 1822 1817 1812 1807 1802 G. William Schwert, 2004-2016
Annualized Standard Deviations of U.S. Stock Returns from Monthly Returns in the Year, 1802-2016 80% Republican Presidents in Red 70% 60% 50% 40% 30% Return Standard Deviation per Year 20% 10% 0% 2012 2007 2002 1997 1992 1987 1982 1977 1972 1967 1962 1957 1952 1947 1942 1937 1932 1927 1922 1917 1912 1907 1902 1897 1892 1887 1882 1877 1872 1867 1862 1857 1852 1847 1842 1837 1832 1827 1822 1817 1812 1807 1802 G. William Schwert, 2004-2016
Annualized Standard Deviations of U.S. Stock Returns from Monthly Returns in the Year, 1802-2016 80% Republican Senates in Red 70% 60% 50% 40% 30% Return Standard Deviation per Year 20% 10% 0% 2012 2007 2002 1997 1992 1987 1982 1977 1972 1967 1962 1957 1952 1947 1942 1937 1932 1927 1922 1917 1912 1907 1902 1897 1892 1887 1882 1877 1872 1867 1862 1857 1852 1847 1842 1837 1832 1827 1822 1817 1812 1807 1802 G. William Schwert, 2004-2016
Annualized Standard Deviations of U.S. Stock Returns from Monthly Returns in the Year, 1802-2016 80% Republican Houses in Red 70% 60% 50% 40% 30% Return Standard Deviation per Year 20% 10% 0% 2012 2007 2002 1997 1992 1987 1982 1977 1972 1967 1962 1957 1952 1947 1942 1937 1932 1927 1922 1917 1912 1907 1902 1897 1892 1887 1882 1877 1872 1867 1862 1857 1852 1847 1842 1837 1832 1827 1822 1817 1812 1807 1802 G. William Schwert, 2004-2016
Links to Real Economic Activity: The Unemployment Rate During the Great Depression, the unemployment rate and stock volatility moved closely together Not true since that time While Candidate/President Obama s statement alluding to the Great Depression was accurate for stock volatility, it is far off for the unemployment rate The unemployment rate since 2008 has not been greater than it was from Sept-82 through June-83
Standard Deviation of Monthly Stock Returns from Daily Returns in the Month and Civilian Unemployment Rate, 1929-2016 30% Unemployment Rate Stock Volatility 25% 20% 15% 10% 5% Monthly Standard Deviation or Unemployment Rate 0% 2016 2013 2010 2007 2004 2001 1998 1995 1992 1989 1986 1983 1980 1977 1974 1971 1968 1965 1962 1959 1956 1953 1950 1947 1944 1941 1938 1935 1932 1929 G. William Schwert, 2011-2016
International Volatility Following figures show historical volatility for: FTSE All Shares Index in London since 1968 the Nikkei 225 and Topix Indexes in Japan, since 1950 They all move together, increasing modestly during the Technology bubble from 1998-2002 Increased substantially in 2008-2009 during the liquidity crisis
80% 70% 60% 50% 40% 30% 20% 10% 0% Annualized Standard Deviation of Returns 2011 1968 1970 1971 1973 1974 1975 1977 1978 1980 1981 1982 1984 1985 1986 1988 1989 1991 1992 1993 1995 1996 1998 1999 2000 2002 2003 2004 2006 2007 2009 2010 2013 2014 2016 Volatility of FTSE All Shares Index, 1968-2016 G. William Schwert, 2001-2016
Foreign Markets FTSE (UK) Volatility in 2008-2009 was similar to late 90 s early 2000 s, and similar to US levels Also similar to 1973-74 (first OPEC crisis) By comparison, Brexit seems pretty modest...
Volatility of Nikkei 225 and Topix Indexes, 1950-2016 40% 35% Nikkei 225 Topix 30% 25% 20% 15% 10% 5% 0% Annualized Standard Deviation of Returns 2005 2007 2009 2011 2013 2015 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1995 1997 1999 2001 2003 G. William Schwert, 2009-2016
Foreign Markets Nikkei 225 and Topix (Japan) Volatility in 2008-2009 was similar to 1989-2003, and similar to US levels Also similar to 1973-74 (first OPEC crisis)
Sometimes Sectors Drive Market Volatility: Technology in 2000-2002 Next figure shows the implied volatility series published by CBOE with ticker symbols VIX (S&P) and VXN (Nasdaq) VXN is much higher, especially in 1998-2002; similar since mid-2007 Also, Datastream Index of US Technology Stocks, 1972-2016
140% 120% VIX VXN 100% 80% 60% 40% 20% 0% 2011 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Implied Annual Standard Deviation of Returns 2012 2013 2014 2015 2016 Implied Volatility for S&P 500 (VIX) and Nasdaq 100 Portfolio (VXN), Annualized Standard Deviation of Returns, 1986-2016 G. William Schwert, 2001-2016
Volatility for Datastream Index of US Technology Stocks, Annualized Standard Deviation of Returns, 1973-2016 120% 100% 80% 60% 40% 20% 0% Volatility (Annualized Standard Deviation of Return) 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 (c) G. William Schwert, 2009-2016
Was the 2008 Credit Crisis a Finance Bubble? Next figure shows historical volatility for: the S&P 1200 Financial portfolio and the Datastream US Financial portfolio, since 1973 They move together, increasing modestly during the Technology bubble from 1998-2002 Increased substantially in 2008-2009 during the liquidity crisis
1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 40% 35% 30% 25% 20% 15% 10% 5% 0% Volatility for Index of Financial Stocks, Annualized Standard Deviation of Returns, 1973-2016 Volatility (Annualized Standard Deviation of Return)
Summary Market-level volatility often rises after prices fall Recent good performance of the market is consistent with the lower levels of volatility [counter-cyclical] Inflation of index levels exaggerate perceptions of increased volatility
Summary Because volatility is easy to see in real time, it has become a major focus of the news media and politicians and, therefore, of main street America For most people, who should be buy-andhold long-term investors, short-term burst of volatility should not be a cause of concern