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business newsThe Sun Sets on the Age of Volatility
The "new normal" is likely to excite old-fashioned stock pickers and frustrate volatility junkies.
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I believe the challenge for investors going forward is how we're going to adapt if we move to a less volatile, less correlated world. In the 35 years between 1952 and 1986 there were 477 days where the S&P 500 had 1-month realized volatility in excess of 20% (implied volatility is usually higher than realized volatility so think of this as a VIX level of 23ish). In the four years between 2008 and 2011 we've had 510 days like this. Between 1952 and 1986 there were 83 days where the S&P 500 fell at least 2%. Between 2008 and 2011 there were 100. Essentially, we've had more volatility in the past four years than investors experienced between the Eisenhower and Reagan administrations combined. There were more 2% down days between July 27 and December 8 of last year – 19 – than there were between the years 1975 and 1981, or 1991 and 1997. Patience, perspective, and a long-term time horizon have become the scarcest assets around.
To someone whose entire memory of the stock market is between the years of 1998 and 2011 – myself – this is a somewhat terrifying and challenging concept. What is it like to invest in a world where nobody cares about tier 1 capital ratios, sovereign debt ratings, or the employment component of the ISM manufacturing index?
As we take stock of the US economy in early 2012, the housing industry has more or less bottomed and a generation of Americans has seen the destruction caused by a housing bubble, making it unlikely that we'll go through anything similar for decades. Banks, while continuing to work through legacy problems, are likely to be cautious if not fearful for several more years if not longer. Non-financial corporate leverage is at generational lows. Household debt service ratios, thanks to ultra low interest rates, are closer to a trough than a peak. Manufacturing's role in the economy has become much more like the agricultural sector – still meaningful, but no longer large enough to create big booms and busts. The service sector, of course, is prone to excesses of confidence and pessimism like any other part of the economy, but it is far more stable. It's possible, perhaps even likely, that the next 20-25 years of the US economy could look like the years between 1946-1970, a relatively uneventful time macro-wise with recessions lasting no more than two to three quarters. I often wonder about what it must have been like to live during the period of social mood that produced TV shows like Leave it to Beaver, before Don Draper found the world so confusing.
There will still be plenty of investment opportunities for those who can look at the world and see things that others can't. But rewards are more likely to accrue to those who can spot the next Walmart (WMT) or Microsoft (MSFT), or see what big-picture themes that nesting Millennials are embracing, not to those who can extrapolate what a change in Italian government bonds means for semiconductor stocks. The “new normal” is likely to excite old-fashioned stock pickers and frustrate volatility junkies.
Twitter: @conorsen
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