Market volatility: Shifting sands

It’s a real roller coaster | The most commonly cited measure of market volatility, the VIX, is nicknamed the “fear gauge.” It measures how much investors expect the US stock market to go up or down, and while up is not so bad, the possibility of a big drop gets investors scared. But the VIX isn’t really a measure of fear—it’s a measure of uncertainty. Elroy Dimson, emeritus professor of finance at the London Business School, is said to have summed up risk as the fact that “more things can happen than will happen.” Volatility reflects the difference between the two. Technically, volatility is the amount the price of an asset or a market changes over time, measured by standard deviation. Prices change in response to new information and so “Essentially, it’s the news that causes volatility,” [says Roger Ibbotson](, a professor emeritus at Yale. The VIX measures, in part, how much investors expect to be surprised by tomorrow’s headlines. Let’s summon our courage and dive in. 🐦 [Tweet this!]( 🌐 [View this email on the web]( Sponsored by [Quartz Weekly Obsession] Market volatility April 29, 2022 It’s a real roller coaster --------------------------------------------------------------- The most commonly cited measure of market volatility, the VIX, is nicknamed the “fear gauge.” It measures how much investors expect the US stock market to go up or down, and while up is not so bad, the possibility of a big drop gets investors scared. But the VIX isn’t really a measure of fear—it’s a measure of uncertainty. Elroy Dimson, emeritus professor of finance at the London Business School, is said to have summed up risk as the fact that “more things can happen than will happen.” Volatility reflects the difference between the two. Technically, volatility is the amount the price of an asset or a market changes over time, measured by standard deviation. Prices change in response to new information and so “Essentially, it’s the news that causes volatility,” [says Roger Ibbotson](, a professor emeritus at Yale. The VIX measures, in part, how much investors expect to be surprised by tomorrow’s headlines. Let’s summon our courage and dive in. 🐦 [Tweet this!]( 🌐 [View this email on the web]( By the digits [82.69:]( The highest recorded level of the VIX, as of this writing, reached on Mar. 16, 2020 [-20.47%:]( The biggest single day loss of the S&P 500, recorded on “Black Monday,” Oct. 19, 1987 [β:]( The symbol for “beta,” a measure of risk that can’t be diversified away [1990:]( The year William Sharpe, Harry Markowitz, and Merton Miller won the Nobel prize in economics for work in the ‘50s and ‘60s defining how investors should respond to uncertainty [$1.4 trillion:]( The amount you could turn $1,000 into if you had traded every stock perfectly in 2021 Giphy Cruel, cruel summer --------------------------------------------------------------- Investors don’t fear uncertainty, they fear losing money. But investing in something volatile doesn’t have to mean a loss, thanks to diversification, which Mihir Desai, a finance professor at Harvard Business School, [calls]( “the only true ‘free lunch’ in finance.” Here’s an example borrowed from the classic book [A Random Walk Down Wall Street]( by Burton G. Malkiel. Imagine two investments: a vacation resort and an umbrella company. Investing in the resort returns a hefty amount if it’s a sunny summer and loses a smaller amount if it’s a rainy summer. The umbrella company is the reverse. Imagine the chance of a rainy summer is 50%. Both investments have a positive expected return—the upside under ideal conditions is larger than the downside under bad ones. But they’re risky, which is to say they’re volatile businesses. Invest in one and you could easily end up losing money. But what if you invest in both? If it’s sunny, the big return from the resort outweighs the smaller loss from the umbrella company; if it rains it’s the reverse. By diversifying across both companies, you’ve guaranteed a return. Sponsored by Fidelity Never miss an opportunity. --------------------------------------------------------------- Trade with Fidelity and get heads-up alerts on market events that could affect your portfolio. For smarter trading decisions, get Decision Tech® from Fidelity.[Advertisement][Learn more]( Giphy Pop Quiz! According to many experts, what’s the best way to react during a time of volatility? Stand in the middle of the street and screamBuyWaitSell Correct. Of course every investor’s situation and risk preferences are different, but one novice mistake is selling when the price dips. For most individual investors, the best strategy is to buy and hold: volatility has a way of averaging out in the long run. If you can’t afford to wait that long because you need the money now, better to stick to safer, less volatile investments. Incorrect. Deep breath. Now try again. If your inbox doesn’t support this quiz, find the solution at bottom of email. Beta-maxing --------------------------------------------------------------- Investors have long understood that when they take on more risk they expect a higher payout in exchange. A highly volatile stock should have a higher return than a less volatile Treasury bond. But in [the early 1960s]( a group of finance professors revolutionized the understanding of risk and volatility. Their breakthrough was in understanding that any risk that can be diversified away won’t have a higher return. Recall the example of the resort and the umbrella company: Someone who has invested in both no longer has to worry about whether the sun will shine. But some risks can’t easily be diversified away, and those are the ones that earn a higher return. That sort of risk is captured by a concept called “[beta](,” which measures how much an investment rises or falls with the rest of the market. Some investments, like gold, have especially [low betas](, because they do best when the market does poorly. But most investments are at least a little bit correlated with each other, and so markets worry the most about the sort of news that causes the price of lots of different assets to drop at the same time. Charting[A line chart of the VIX Index, also known as the fear gauge. It has lots of spikes between 1990 and 2021, but they look very small next to the spikes of 2008 and 2020.] Sponsored by Fidelity Never miss an opportunity. --------------------------------------------------------------- Trade with Fidelity and get heads-up alerts on market events that could affect your portfolio. For smarter trading decisions, get Decision Tech® from Fidelity.[Advertisement][Learn more]( take me down this 🐰 hole! Too little of a bad thing --------------------------------------------------------------- Is there such a thing as too little volatility? Some traders think so, because less price movement means fewer opportunities to make money. But some economists have thought so, too. Hyman Minsky, the famous 20th century US economist, argued that “[stability is destabilizing](.” His logic was that when volatility is low, investors get comfortable and take on extra risks. A [2015 paper]( found evidence in support of that thesis: Low volatility was linked to a higher chance of a financial crisis. Giphy Poll How’s your stress level these days? [Click here to vote]( You could say I’m feeling pretty volatileSurely it’ll all work out (??)I’ve been grinding my teeth so much I’m not sure I have molars anymore 💬 let's talk! In our last poll about [patents](, 45% of you said you probably wouldn’t invent or discover something and therefore wouldn’t need to file a patent, but 34% said you were born inventors! ✉️ Jim wrote in to say that we should have clarified that patent protect the right to exclude others from making, using, or selling the invention. Thanks, Jim! Today’s email was written by [Walter Frick]( (known for his even keel), edited by [Susan Howson]( (oscillates between loud and quiet with alarming suddenness), and produced by [Julia Malleck]( (stable at room temperature). [facebook]([twitter]([external-link]( The correct answer to the quiz is Wait. Enjoying the Quartz Weekly Obsession? [Send this link]( to a friend! Want to advertise in the Quartz Weekly Obsession? Send us an email at ads@qz.com. Not enjoying it? No worries. [Click here]( to unsubscribe. Quartz | 675 Avenue of the Americas, 4th Fl | New York, NY 10011 | United States