by Denise Chisholm, Director of Quantitative Market Strategy, Fidelity Investments
The market has felt unusually jumpy lately. One month stocks are surging, the next they're pulling back, only to reverse course again. By my measure, that's not just a feeling. Looking at the standard deviation of monthly returns over the previous three months, a gauge designed to capture what a longer-term investor actually experiences when reviewing account statements, today's market ranks firmly in the highest decile of history going back to the 1940s. That's different from the intraday volatility traders watch or the traditional quantitative definition of volatility that often overlaps with beta. This is simply a measure of how much your portfolio value is swinging from month to month.
What's particularly interesting isn't the magnitude of today's volatility, but its persistence. This cycle has spent more time in the highest quartile of volatility than any other period in the historical record. That sounds alarming, but the volatility itself is not unprecedented. In fact, the average level was actually higher from the late 1970s through the mid-1990s. As we've noted before, one of the defining features of this cycle has been duration. Whether it's elevated valuations, earnings strength, or now volatility, the uniqueness tends to come from how long the trend has lasted rather than how extreme it has become.
That leads to the more important question: should investors view today's volatility as a warning sign for future returns? History suggests the answer is no. In fact, the relationship appears to run in the opposite direction. The higher the starting point for volatility, the stronger subsequent equity returns have tended to be. When volatility begins in the highest decile, as it does today, the market has historically gained roughly 20% over the following year and advanced 96% of the time. As uncomfortable as volatility may be, it has often been a feature of good markets rather than a bug.
There may be a fundamental explanation. Earnings growth remains strong, but given that growth is already running near top-quartile levels historically, some degree of deceleration over the next year is more likely than not. Importantly, decelerating earnings growth has not historically been a major problem for returns. Markets have produced similar return profiles whether earnings growth was accelerating or slowing. Where the difference shows up is in volatility. Periods of earnings deceleration tend to come with more back-and-forth market swings than periods of acceleration. In that sense, today's choppier environment may simply reflect what investors should expect as growth normalizes from unusually strong levels.
So what's an investor to do? If the objective is long-term total return, the lesson from history is not to confuse volatility with deterioration. Markets rarely travel in a straight line, and some of the strongest advances have arrived wrapped in a surprising amount of discomfort. Higher returns have often required investors to tolerate a bumpier ride. The challenge isn't predicting the next swing. It's resisting the temptation to react to it. The bad news is that volatility rarely feels good in real time. The good news is that, historically, neither have some of the market's best opportunities.
This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.
