Stock market volatility has been elevated since late 2021. Being among the stock investors who’ve gone through the market’s ups and downs, I can remember how things started.
It was the day after Thanksgiving. Tech stocks began to dive hard, with many of the stocks I tracked declining double digits in a single day.
From that moment, tech stocks and the broader S&P500 index started to go down. The Nasdaq bottomed about a year later, on December 28, more than 35% off the record high.
The S&P500 bottomed in October 2022. That index was 25% off its high.
Stock market volatility was highest in 2021 and 2022.
Stock market volatility refers to the frequency and magnitude of changes in the prices of stocks traded in a particular market. High volatility means that stock prices fluctuate rapidly and unpredictably, while low volatility indicates more stable prices. One way to measure volatility is with the VIX.
The Chicago Board Options Exchange (CBOE) Volatility Index, or VIX, is one of the most widely used measures of stock market volatility. The VIX is sometimes referred to as the “fear index,” as it tracks the expected volatility of the S&P 500 index over the next 30 days.
While it might not be a reliable predictor, it does give you a sense of overall volatility at the moment. Here’s the VIX chart for the past 12 months:
Implied volatility has been going down gradually after being elevated for more than a year. It started going down in October 2022, right around the time the S&P500 bottomed.
Volatility is highest when investors don’t agree
The reason I’m sharing this recent example of volatility is that it always follows the same pattern. When the economy is facing headwinds, investors are highly divided and more cautious, which causes big swings in the market.
Contrast that with periods when the majority of investors are on the same page. A good example of that is April 2020, when the Federal Reserve injected massive amounts of capital into the economy.
The stock market went up in a straight line. For a few months, you couldn’t find serious investors who weren’t bullish.
But after a while, some investors paused and realized that all this stimulus will cause a range of other problems including inflation and supply shocks. From that point, the financial community hasn’t been aligned.
This is how I view the stock market. If there’s consensus on a direction, we will move in a clear line toward that direction. Think of the entire year of 2022. All investors were cautious about inflation and the looming risks of a recession.
But as inflation came down and the economy kept growing, more investors started to turn bullish. That’s why the S&P500 and Nasdaq 100 were up through the first five months of the year.
This divide is best demonstrated by Ken Griffin and his hedge fund, Citadel. In an interview with Bloomberg, Griffin admitted that his team believed the US economy would avoid a recession in 2023.1Source: Twitter But Griffin himself was skeptical and believed the economy would see a recession in mid-late 2023.
Warren Buffett recently said that the “incredible period” of the economy has already ended and that “the majority of our businesses will report lower earnings this year than last year.” This implies he sees a slowdown but not necessarily a recession.
“The market is positioning for a mild recession and certainly there is risk it could deteriorate further until the Fed really pivots towards cutting rates.
All of this is to say: No one knows what will happen. And investors will place their bets in the stock market. That’s what makes the stock market always right in the long run.
Volatility is a non-issue for long-term investors
If you’re a long-term investor and you get caught up in volatility measures, you’re lost. A lot of traders and investors think that high volatility means more opportunity to profit.
Recent trades that played into volatility didn’t play out well. In February 2023, the WSJ reported that bets on a rising VIX were higher than at any time since March 2020.5Source: Wall Street Journal The VIX has been between 15% to 20% lower as I’m writing this compared to when the WSJ article was published.
The old adage of “you can’t predict the market” seems to be interpreted as a challenge by many investors instead of an absolute.
“But I need to hedge my portfolio against volatility!”
That’s something everyday investors think. I don’t know where this line of thinking comes from, but unless you work in finance or manage other people’s money, you don’t have to hedge against anything.
If you have a long-term strategy that works, stick to it. Don’t get swayed by volatility. And certainly don’t try to “protect” yourself because you’re only giving up returns.
The long-term direction of the stock market remains up. If you keep investing long enough, volatility is a non-issue.
My strategy is to invest in an S&P500 index fund. Last year, it wasn’t fun to look at my portfolio. But who cares?
I keep investing and understand that high volatility doesn’t change anything about my strategy. Instead of worrying about short-term downturns, focus on improving your discipline.
See volatility as a way to improve discipline
If you see the market going up and down as an investor, what do you feel? You likely feel a mix of emotions, including excitement, fear, and anxiety.
Market volatility might feel scary or risky, but it’s actually an opportunity to improve discipline and double down on your investment strategy.
That will help you to develop the mental fortitude required for long-term investment success. As a disciplined investor, you’re better equipped to navigate market fluctuations.