Wall Street Journal
Many investors are entering this week with fresh hopes the worst is over, after last week’s sudden stock-market rebound. But history suggests that in times of market turmoil, there is a risk that big, sudden gains like last week’s will prove temporary respites before stocks fall again. Head-snapping volatility, both steep drops and sharp gains, most often comes in times of market trouble. It suggests that, despite the bounce last week, the market isn’t healthy, says economic historian Richard Sylla of New York University’s Stern School of Business. « Financial markets become more volatile in periods of stress. People don’t know which way things are going to go, so you get these big up and down movements as people pile in and get out, » he says.
The volatility has been relentless, amid fears of European debt defaults and U.S. recession. Starting on Sept. 21, the Dow Jones Industrial Average moved more than 1% on 11 of 13 trading days; five moves exceeded 2%. That much volatility isn’t normal. Since 2000, the Dow has moved an average 0.87% a day, up or down. Since the start of August, the average move has been almost twice that—1.69%. After falling almost 17% from late April through last Monday, Oct. 3, the Dow rose more than 1% on each of the next three days. Including those three, the Dow rose or fell more than 1% on nine consecutive days. (For the week as a whole, the Dow was up 1.7%.)
The market’s recent swings have been so wild that clients have been phoning money-manager Richard Steinberg to ask about his health. « People call to say, ‘We are just checking on you guys because we know you have the hardest job in town right now. We need you to be doing OK so we know we are doing OK,' » says Mr. Steinberg, who oversees about $460 million at Steinberg Global Asset Management Ltd. in Boca Raton, Fla. People are right to worry, not about Mr. Steinberg—who says he is fine—but about the health of the market.
Most years since 1900 had no instances at all when the Dow rose or fell 4% in one day, according to Ned Davis Research in Venice, Fla. There weren’t any last year. But there have been three this year, all since August, and all of them down. The Depression and the 2008 financial crisis were also populated with such big swings. In 1931, there were 26 days with 4% moves. In 2008 there were 22. Stocks also have been swinging sharply within the day. Last Tuesday, the Dow was down 2.75% but then recovered all that and more to finish up 1.44%. The renewed volatility suggests the market trouble may not be over. And the bigger the market swings, the less likely skittish investors are to return to the market.
« The more this happens, the more people are discouraged from participating in common stocks, » says Jerry Harris, who helps oversee about $500 million as head of Sterne Agee Asset Management in Birmingham, Ala. « It damages the psyches of individuals and even some institutions that would like to be investors and behave rationally. » he says. « They find it very difficult when individual stocks can move 10% to 20% in two or three days and then move that same amount the other way in the next two or three days. »
In periods of such turmoil, some long-term investors get burned by the sharp swings and pull back, leaving the market increasingly in the hands of short-term players such as hedge funds and high-frequency traders. The pullback by those with longer-term goals makes markets even more volatile. It isn’t surprising that nine of the 20 biggest one-day Dow percentage declines came in the decade starting with the 1929 crash. Four more were in 2008, during the financial crisis, and two in 1987, at the time of that year’s crash, according to The Wall Street Journal’s Market Data Group. What is surprising is that big one-day gains also tend to come in troubled times, often proving to be temporary rallies in bear markets. Of the Dow’s 20 biggest one-day percentage gains, 16 came in the decade that began with the 1929 crash. Two more came in 2008.
Some people clearly are losing confidence.
In every month since the start of May, investors have withdrawn more money from U.S. stock mutual funds than they put in. The net withdrawal was more than $93 billion in that period, according to the Investment Company Institute, a mutual-fund trade group. As long-term investors pull back, « hot-money » investors accentuate volatility by using borrowed money to make heavy one-way bets on stock moves. Some use vehicles called leveraged exchange-traded funds, which trade on regular stock exchanges and use borrowed money, enabling investors to make amplified bets. When this kind of trading dominates, stocks can swing heavily up on one day, down the next, and then up again. That kind of activity, which is exceptionally rare in normal market periods, is what has been happening lately. The Dow has moved more than 1%, close to close, on 33 of the 49 trading days since August began. That included 17 gains and 16 declines. The average moved more than 2% on 17 of those days and more than 3% on seven, and most of the bigger moves were down.
Overall, the Dow is off 13% from its April peak.
High volatility doesn’t inevitably lead to more market declines. It also can come when a bad period is ending and investors are piling into stocks as they turn bullish again. Some think stocks could be bottoming out now. But in such a bounce-back period, the stock gains tend to include exceptionally heavy trading volume, which hasn’t been the case this time. The economic problems that caused the recent declines haven’t been solved, and many analysts fear more trouble could await. « There are no investors. It is just hedge funds and high-frequency traders. Until we get investors back to the market, we will have really tough markets; this kind of nonsense will continue, » says Phil Roth, chief technical market analyst at New York brokerage Miller Tabak + Co