Last Updated Aug 11, 2011 9:50 PM EDT
In just over a week, the Dow has risen and fallen a total of more than 2500 points -- enough to give even the most iron-willed investor pause.
So is it just our imagination, or are the markets more volatile than ever? And if that's true, why is it so?
First, to state the obvious, it's true that over the past few years we've endured more than our share of stock market volatility -- but it's not unprecedented, or even record-breaking.
Since the Fall of 2007, the Dow has seen 154 days with swings of more than two percentage points in value. Yes, that's a lot. To put it in perspective, we've endured more of these big swings in market value during 3-plus years than were seen in the 1950s, 60s, and 70s combined. Even the 1990s -- which were far from placid, if not as gut-wrenching -- had only 93 of such days.
So what's driving this increase in volatility? Part of the explanation is the rise of quant managers and their computer-driven trades. It's estimated that these traders account for upwards of 70 percent of daily market volume, and they generate an enormous amount of churn. Their typical holding period is measured in minutes, if not seconds.
Furthermore, most of these traders prefer to "zero out" their holdings at the end of the day, going to cash overnight. That's not so much of a problem when there's a ready group of buyers for their shares. But when there's not, prices can fall precipitously in a matter of minutes.
These enormous price swings also end up triggering stock sales. As prices fall, large institutions are forced to liquidate their holdings to protect against further losses, which only puts more pressure on prices.
But I'm skeptical that that fully explains the volatility we've been witnessing, and the biggest reason for that is history.
If you think the market's nuts now (and it is), it pales -- thus far -- in comparison to the 1930s. During that decade, investors endured 560 days in which the market rose or fell by more than two percent. To put that in perspective, that means that there was roughly one of those days every single week for the entire decade.
What's the common variable between the 1930s, the past 3-plus years, and even the early part of this decade? Uncertainty.
Short-term investors can't stand uncertainty. And in each of those periods investors were wrestling with the short-term implications of a cloudy -- if not downright dire -- economic picture. And when you take today's economic uncertainty and layer on top of it the vastly diminishing faith we have the ability of our (if not the world's) political leaders to act like the grown-ups they claim to be, you get a great deal of uncertainty about what that means for the markets' short-term outlook.
But make no mistake. The volatility we're witnessing today is driven entirely by short-term investors, whose vision doesn't reach beyond the current day. Their movement into and out of the stock market is driven far less by the fundamental values of the stocks they're buying and selling, but by their own fear and greed, and by what they believe their fellow speculators' fear and greed will motivate them to do.
I'll leave it to wiser heads to debate the correct value of corporate America today, but I know one thing for certain -- it's not worth 17 percent less than it was one month ago, as the market indicates it is.
As difficult as it is in times like these, long-term investors know that the insanity that surrounds them today is mere noise in the long-term picture, and has nothing whatsoever to do with the fundamental values of corporate America.
I was talking the other day with some colleagues, one of whom just had a baby last week. Someone remarked that he'd long remember Thursday due to the market's 635 point loss. My friend said he'd also long remember Thursday, because that was the day his son was born.
I strongly suspect that ten years from now, only one of them will be true to their word, and be able to recall why August 4, 2011 was so memorable.
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