05 Dec This Time is Different?
“This Time is Different” is considered by many to be one of the most dangerous phrases to utter. When trying to contextualize recent events, it is tempting to ignore times past, especially when it comes to volatility. But, volatility, maybe more than performance, is dependent on whether one take a short- or long-term perspective.
Many have expressed concern about unusually low volatility, specifically in the U.S. equity market. But, low relative to what? In simple terms, volatility, the standard deviation of a time series, is a function of two variables – how far back one looks and how often one reviews the price changes. A short-term perspective might consider volatility every 90 days and contextualize it by comparing the volatility to the average 90-day volatility since the 2008 crisis. Comparing the same volatility with the average from 1954 to the present might yield different results.
The fact is that realized volatility is relatively low, but a nuanced view is needed. Ninety-day, 1-year, and 3-year volatilities are below average (but higher than lows realized in 2014) when compared with their averages from 2008 to the present.
However, the conclusion is different when analyzing a longer period – 1954 to the present. (Note: The S&P 500 time series begins in 1950). Ninety-day and 1-year realized volatilities are below their averages. However, 3-year volatility is above its average. This is true for the S&P 500 as well as the Broad Market index, a value-weighted index of all U.S. equity securities, from the Kenneth French data library. While 3-year volatility is average, it is trending downward.
In summary, realized volatility is low if you limit your reference period to the 8 years following the 2008 crisis. Otherwise, the conclusion is mixed depending on your preferred measure – 90-day or 3-year. Three-year realized volatility has started to trend downward. So, concerns about persistent low volatility may be warranted, but premature. In terms of the debate between using a recent 8-year reference period and a broader 60-year period, the jury is still out as to whether this time is truly different.
The next post will look at small company outperformance after the election.