Many people become concerned when they see stock markets displaying the kind of high volatility they have in recent weeks.
Normally, share indices move up or down by less than 1% in a day, but over the course of September, there were nine days on which the FTSE 100 Index, which measures the performance of the largest 100 UK-listed companies’ share prices, experienced massive turmoil. Falls of over 3.5% on the 5th and 22nd of the month resulted in ‘stock market slump’ media reports.
Volatility
Volatility is a response to uncertainty. When there is a broad consensus about the economic outlook, as there was during the economic recovery in 2009, stock markets often develop a steady trend. But when it is not at all clear what is going to happen next, share prices can go through periods of high volatility until a consensus does emerge.
Today, commentators cite two main causes of volatility: the ongoing euro crisis and fears about the pace of global economic growth. In both cases, there are wide differences of opinion about what is likely to happen. Some think a Greek default will lead to the break-up of the euro, others that the eurozone will muddle through. Some think the current slowdown in economic growth in the developed world and China is a temporary interruption of a recovery, others that it signals a recession.
The future is unknowable
It is important to understand that while stock markets are barometers – they reflect what is happening today – they are not that good at predicting what will happen. Nobel prizewinning economist Paul Samuelson, regarded as the father of modern economics, put it like this: “Commentators quote economic studies alleging that market downturns predicted four out of the last five recessions. That is an understatement. Wall Street indexes predicted nine out of the last five recessions!”
So if you have committed capital to the stock market for the long term as part of a balanced portfolio, you should not be too swayed by day-to-day movements – up or down. Such movements are ‘the nature of the beast’ – volatility is the price you pay for returns that have, over the long term, been higher than those from cash deposits or fixed-interest investments.
And if you are saving regularly, then in fact you may benefit from volatility, since it can lower the average price at which you purchase investments. If you do have concerns about your savings or investments, we will be happy to discuss these with you. Past performance is not a guide to future performance. Investments can go up or down, and you may not get back the original amount invested.