Stocks’ wild ride
Anxieties about the global economy are fueling big market swings - and Wall Street observers expect volatility to continue for awhile
Stock markets have calmed down over the past few days, but economists and analysts warn that investors face years of severe market swings until national debt crises and other threats to the global financial system are finally resolved.
These swings, known as volatility, are at their highest level since fall 2008, when the financial crisis spurred months of frenzied trading that eventually drove the Dow Jones industrial average below 7,000 - a loss of more than half its value from the market peak.
The recent stock market plunges haven’t been nearly as big and frightening as what occurred three years ago, but a measure of volatility, the Chicago Board Options Exchange market volatility index, or VIX, is running at about double normal levels.
“We’re still in relatively uncharted waters,’’ said Kenneth Rogoff, a Harvard University economics professor who has studied 800 years of financial crises. “There’s no doubt we’ve just been through a period of tremendous volatility and will probably have elevated volatility for a few more years.’’
Several factors are unsettling markets, analysts said, but the underlying cause is uncertainty about the global economy. The recent volatility centers on the European debt crisis, the weakening US recovery, and fears that policy leaders here and across the Atlantic will be unable to quickly take the necessary steps to address financial and economic threats.
Compounding market swings is the increased use of high-frequency trading, the rapid-fire computerized transactions often based on complex software models developed by hedge funds and other big investors. There are no reliable figures on how much market activity is attributable to high-frequency trading, but anywhere from 30 percent to 70 percent of stock trades are made via computer, economists said.
While high-frequency trading has probably added to recent volatility, it isn’t the cause, analysts said.
Philip Roth, chief technical market analyst at brokerage firm Miller Tabak + Co. in New York, said he believes changed attitudes toward stock investments have pushed markets into a “secular correction’’ that could last 10 years, while producing heightened volatility. A secular correction occurs when average stock prices remain relatively flat, or move “sideways,’’ over many years, with big up-and-down swings along the way, Roth said.
Individual investors, whether through individual retirement accounts or 401(k) savings accounts, are the backbone of a stable market because they are long-term investors who buy and hold, rather than trade for short-term gain. But millions of individual investors, who got hammered by the dot-com crash a decade ago and again in 2008, haven’t returned to the market - and may never will, Roth said.
He compared them to the average Americans who forever abandoned stocks after the Great Crash of 1929.
“It’s going to take a generation to fix this,’’ Roth said. “Hedge funds today are only trading with each other, all with short-term goals in mind. Until we get individual investors back, volatility is going to be here some time.’’
Earlier this week, the VIX index was running at about 41 percent, half of the rate of 2008 but still more than double the normal range. The VIX measures expectations for stock prices based on the trading of stock options, which allow an investor to buy a stock at a set price in the future.
A normal VIX range anticipates an average stock price swing of 15 to 20 percent over the course of a year. In the fourth quarter of 2008, the VIX was running at an 85 percent annualized rate.
“What’s unique is the volatility of the volatility, ’’ said Andrew Lo, a finance professor at MIT’s Sloan School of Management. “In other words, we may experience periods of low or normal volatility, but punctuated by sharp spikes in volatility as new political events unfold.’’
Another way to look at recent volatility is to compare the Dow Jones industrial average’s swings this month to 2008.
The Dow declined nearly 1,300 points during the first three weeks of this month, with six trading days left in August. That’s not too far off the Dow plunge of 1,525 points in October 2008, the worst month of the Wall Street financial crisis.
Few economists expect the Dow to come close to the plunge of 2008 and 2009. But the intensity of the past month’s volatility remains disturbing, analysts said.
“I believe we’ve entered a bear market, so we’re going to have a period of uncertainty,’’ said Mark Arbeter, chief technical strategist at Standard & Poor’s. “With uncertainty comes more volatility.’’
