What is Volatility and is it Normal?

Investor uncertainty and stock market volatility defined the 4th quarter of 2018, as we experienced the first significant pullback in US stocks in nearly a decade. Not every year yields positive stock market returns, and at times, an entire year’s return can be reversed in a matter of months.

Yet, volatility is both a natural and necessary fact of investing in stocks. The adage, “no risk, no reward” still holds true as we put the 4th quarter in our rearview mirror.

Volatility is defined as how much variation there is in the price of a given stock or index of stocks; simply put, how widely a price can swing up or down. It is generally considered to be a measure of the level of risk in an investment. Typically, low volatility is associated with positive market returns and high volatility with negative market returns. However, volatility can be high when stocks are increasing or decreasing in value. It does not tend to be a focus in the news in a good market for obvious reasons.

We perceive the unpredictability of stock markets more acutely when volatility is higher than in previous periods. What better recent example of that than 2018! As you can see in the chart below, the previous year, 2017, was the first year in thirty years where there were no negative months in global stocks, as measured by the MSCI All World Stock Index (ACWI). 

Investors can be lulled into complacency about stock market risk in such low volatility environments. 2018’s market movement felt more extreme than it otherwise would have, because it followed on the heels of the extraordinarily placid 2017 market. How might we put that into perspective and understand when volatility is above normal levels?...

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