To believe newscasters, stock markets rise when there are
more buyers than sellers and fall with the converse. To consummate a transaction,
there must be both a buyer and seller. It is more proper to say that stock
markets rise when more people are motivated to buy shares than sell them at a
given price. To balance that optimism, sellers require more money to part with
their shares. Similarly, price declines reflect that to induce people to purchase
shares, they must lower prices. Whatever the motivations, at the point of transaction,
both parties have agreed to a price.
General agreement on the prospects for stocks results in little
volatility in prices. As what were expected future profits become actualized,
current prices rise to reflect the time value of money. As new information becomes
available to estimate future profits, individual stocks will increase or
decrease—causing what little volatility there is.
Several methods exist to gauge the stock market’s price volatility.
The measure I’ll use for this blog is the daily percentage change in prices of
the S&P 500 Index[i].
Because we are concerned only with how much the market changed each day, not
whether it rose or fell, we use the absolute value[ii]
of the percentage price change.
Historical Averages
For the ten-year period ending April 22, 2020, the average absolute
value percentage change was .82%. The current S&P 500 Index is ~2,800. Applying
the long-term expectation means that, on average, daily prices change by 23
points. Not every day is the same, and standard deviation[iii]
measures the variability around that average. The larger the number, the more the
variability. For the 10-year period, that was 1.04%.
So, the two key measures for the 10-year period are .82% average
change with a standard deviation of 1.04%.
The 2020 Experience
In the beginning of 2020, the stock market was relatively
calm. From January 2 through February 19 (the day the S&P 500 reached its all-time
high), the average change was .57% and the standard deviation during that time was
.44 (or .50 when comparing those thirty-three
daily results to the long-term average change). This calm trading behavior suggests
everyone seemed to think they had the temperature of the market.
That stability has changed markedly since the record high.
In the forty-four trading days since (from February 20 through April 22, 2020),
the average percentage change has exploded to 3.62% with a standard deviation
of 2.73 (or 3.91 when comparing those daily results to the long-term average
change!). The expected daily change of 23 points has exploded to an actual average
of 101. Not only has the daily percentage change more than quadrupled, the
variability of the daily change has also skyrocketed.
Meaning What?
Yeah, fascinating for the number geeks, but what does that
mean? My interpretation is that until we have clarity on two issues, everyone
is shooting in the dark. Each daily statistic shines a penlight worth of knowledge
into a mammoth cave worth of unknowns, and yet the markets react: hence massive
volatility. Issue number one is how much damage are businesses experiencing? First
quarter reports will come out soon. They reflect half a quarter of boom times
and the rest of responding to Covid-19 shelters-in-place. Corporations will not
be providing forward guidance about the second quarter or later. This data will
only partially answer the first question. The Federal Reserve continues to prop
upthe economy and Congress continues to throw money (and ballooning deficits
beyond anyone’s imagination just two months ago) at the problem.
And still we do not know what the short-term damage will
be.
Worse, we have no certainty about what the longer-term
damage will be. Today’s weekly unemployment new claims data are projected to be
4.5 million[iv],
yielding 26.5 million new claims during the month. The unemployment rate will exceed
15%.
Initial words from pundits suggested a V-shaped recession: quick
decline and rapid recovery because financial imbalances did not cause the
problem, and the economy was so strong before the Covid-19 damage. The decline part
is correct. I am not optimistic about the quick recovery.
Our chances of screwing things up seem much larger than
our opportunity to do it exactly right. The U.S. approach has been to focus
primarily on keeping businesses solvent so they can resume operations once
governments raise the green flag. It won’t have been enough for some retail operations
and many restaurants, which is why there is pressure to reopen as soon as possible.
But, reopening businesses too early gives the virus an opportunity to re-accelerate,
causing renewed and longer shutdowns. Delaying reopening causes rank-and-file employees
to dip further into savings or go further into debt, neither option allowing
them to spend at previous levels.
In short, an economy that is 70% driven by consumer spending
can’t bounce back to previous record-low unemployment without everything
returning to normal. Unless Covid-19 magically disappears or treatments become highly
effective, I don’t see a quick restart.
Many supply chains will not seamlessly restart because Covid-19
is affecting various parts of the world in different manners. Most spring events
with large gatherings are canceled. Many are already canceling summer events,
and planners are already canceling some fall events. Each of these has run-on effects
for the hospitality industries and airlines. All this yields more uncertainty.
Which means, volatility will remain high for some time until
the economy’s future becomes clearer. That resolution will determine whether
the stock market is over-valued or under-valued.
[i] All data
based on information provided by https://www.macrotrends.net/2488/sp500-10-year-daily-chart
[ii] The absolute
value of a negative number is determined by changing the negative sign to a positive
sign. E.g. the absolute value of -1 is +1
[iii] Standard
deviation is the square root of the variance. Variance is defined as the sum of
the squares of the difference between each individual value and the mean of
values, that total divided by the number of values
[iv] https://www.usatoday.com/story/money/2020/04/22/coronavirus-likely-lead-another-4-5-million-file-jobless-claims/3004023001/
James
M. Jackson authors the Seamus McCree series. Full of mystery and suspense,
these thrillers explore financial crimes, family relationships, and what
happens when they mix. Furthermore, a
novella is the most recent addition to the series. You can sign
up for his newsletter and find more information about Jim
and his books at https://jamesmjackson.com.
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