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Our Wild Market Is Much More Normal Than You Think

Did the stock market seem wilder than usual last year? Well, it was. During a one-week stretch in August, the Dow Jones Industrial Average (INDEX: ^DJI  ) logged the most volatile string of days since 1932, rising or falling more than 4% in 5 out of 6 trading sessions.

But measured another way, the year may not have been as crazy as you think. Going back to 1928, I looked at how many days the Dow closed either up or down more than 1.5% in each year. It shows that 2011 was indeed a wild one, but hardly unprecedented:

Source: Yahoo! Finance, author's calculations.

In total, there were 51 days in 2011 when the Dow finished up or down more than 1.5%. Since 1928, there are on average 30 days of such high volatility each year. Since 2000, the average has been about 42 wild days per year.

Something else this chart clearly shows: There has been a big jump in market volatility over the last 30 years compared with the 30 before that. The Great Depression in the 1930s saw some of the most volatile years in history. But after that came several decades of calm. From 1947 to 1972, the Dow logged 216 days in total up or down more than 1.5%. Since 2008 -- just four years -- there's already been 242.

The best explanation for the surge in volatility is the increase in high-frequency computer trading. As markets went crazy last summer, Gary Wedbush of Wedbush Securities estimated that as much as 75% of total volume came from high-frequency traders. These traders look to exploit tiny market inefficiencies, not long-term investment opportunities, and can cause wild volatility when they get spooked and exit the market at the same time. That's what happened in May 2010 during the "flash crash," when the Dow fell 1,000 points and recovered a few minutes later.

But rather than gawk or fret over the increased volatility, we should ask: Does it really matter? It's easy to make the case that it doesn't. There have been 15 years since 1928 in which the Dow finished up or down more than 1.5% on more than 50 trading days. After those wild years, the average subsequent five-year market return was about 6% per year -- almost exactly the historic norm. In other words, high volatility in one year doesn't seem to portend poor returns in the following years.

There are actually plenty of years when the opposite is true. The late 1960s saw some of the least volatility in history -- in 1964, there wasn't a single trading day up or down more than 1.5% -- yet in hindsight it was a terrible time to invest, with stocks beginning nearly two decades of flat returns. On the other hand, the most volatile year in history was 1931, which actually ended up being a superb time to buy, with stocks more than doubling within a few years.

Yet most investors, it seems, tend to view volatility the other way. Wild markets spook investors into submission, and calm markets lull them into complacency. This can be incredibly dangerous for those who try to avoid market volatility by cashing out and waiting on the sidelines until things get better. As I've shown before, there have been about 21,000 trading sessions between 1928 and today. During that time, the Dow went from 240 to 12,400, or an average annual growth rate of 5% (this doesn't include dividends). If you missed just 20 of the best days during that period, annual returns fall to 2.6%. In other words, half of the compounded gains took place during 0.09% of days. Most who think they are being smart by trying to avoid volatility end up its biggest victim.

Despite higher volatility, the fundamentals of investing haven't changed. Buying good companies at good prices and holding them for long periods of time still works. Volatility may actually help the process, since it creates more frequent and deeper buying opportunities. As Ben Graham, Warren Buffett's early mentor, used to say, "In the short term, stocks are a voting machine, and in the long term, stocks are a weighing machine." That's as true today as it's ever been.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (11) | Recommend This Article (39)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 13, 2012, at 12:51 PM, portefeuille wrote:
  • Report this Comment On January 13, 2012, at 3:23 PM, ZuluFool1 wrote:

    what would your growth rate be if you took out the 20 worst days? Growth rate if you took out both 20 best and 20 worst days?

  • Report this Comment On January 13, 2012, at 4:50 PM, DJDynamicNC wrote:

    "-->If you missed just 20 of the best days during that period, annual returns fall to 2.6%. In other words, half of the compounded gains took place during 0.09% of days. Most who think they are being smart by trying to avoid volatility end up its biggest victim." <--

    This was the biggest shock of the article for me.

  • Report this Comment On January 13, 2012, at 7:45 PM, gerdixhia wrote:

    Buy xoma you don't have to hold a decade.

  • Report this Comment On January 13, 2012, at 10:39 PM, TrojanFan wrote:


    You hit the nail on the head. This is one of the most frequently cited pieces of market research by the financial advisor and financial planning community and it's also a grossly one sided presentation.

    The stastic comes from a University of Michigan study, I believe. While non-participation in the 20 best days lops a surprising sum off of an investors returns, missing the 20 worst days over the same interval PRESERVES a jaw dropping amount of capital and results in much, much higher terminal values and long-term returns.

    I get so upset when I see this cited because invariably the other side of the coin is almost never presented because the buy and hold marketing machine doesn't want you to know that.

    The lesson: A missed opportunity to buy cheap due to a lack of cash (which is what happens when you invariably end up over invested by be afraid of "missing" the ride up) costs you far more in the long run then non-participation does. It pays more to be an opportunistic buyer and THEN set and forget then it does to just mechanically ride out the market.

    The caveat to this is that the window of opportunity to grab those deals is always extremely short and the bounces off of the bottom are EXTREME once they happen.

    I'd just once like to see a more balanced presentation of the facts for a change.

    If you saw how much missing the 20 worst days added to returns that would blow your mind.

    This also shows another reality about how markets operate. They rise slowly and fall like a rock. They are like an escalator up and an elevator down and it's always been that way. That's because it takes a lot longer and is a lot harder to create value then it is to destroy it. Just ask any ex Bear Stearns or Lehman exec for proof of that. What takes 100 years or more to build can be lost in a matter of days or even hours in the modern information age once credibility and confidence are lost. And when confidence is lost, it takes a LONG time to recover from that.

    That's why taking a bi-directional approach and positioning to the market is such a sensible thing to do. It makes tons of sense to have a long/short portfolio so that you always have some insurance and a chance to cash in on a cratering market while others around you are losing your shirts. That way you have tons of short selling profits to plow into buying the other guys shares when he's puking them out in desperation to meet the margin calls on his long only fully bullish portfolio.

    Investing is not a cooperative endeavor. It is one of the most predatory, competitive and adversarial endeavors on Earth.

  • Report this Comment On January 14, 2012, at 6:44 AM, cmfhousel wrote:

    Zulu, Trojan:

    I calculated the figure myself, and if you click on the link in the word "before" in that section of this article, I address your complaint.


  • Report this Comment On January 14, 2012, at 7:23 AM, daveandrae wrote:

    Anyone that's been around the block in this business knows that "trojanfan" has no idea what he's talking about.

    I will show you the mindset of the common "investor" when an outstanding business is practically being given away. This should go a long way to explain why so many people, against overwhelming odds, still fail to achieve wealth in this business.

    I marked this under "Read again one year from now" in my investment notes. The date was October 21st 2011. Keep in mind, you have to be a subscriber to Barron's magazine ( a complete waste of money, by the way) in order to reply.

Edd Mcdermott wrote: 
"We bring good things to ruin" should be their new motto. Andrew Liveris (DOW Chemical) and Immelt are leaders who stated their dividend will not be cut on their watch...Both, quickly proceeded to slash dividends. Fool me once...etc, etc.Perhaps bifurcation of GE will benefit new and old investors.


    02:17 pm ET October 21, 2011
Tina Patalano wrote: 
If I bought GE every time Barron's recommended it, I'd be broke.


    01:46 pm ET October 23, 2011
Zen Cheru Veettil replied: 
Haha..GE is always "cheap" if you think that GE Capital can bring in trading profits like it used to


    02:12 pm ET October 24, 2011
David Abel replied: 
I will not soon forget the day GE, under Immelt, sold those "special shares with a 10% dividend" to Warren Buffett. Everyone that held common GE shares got an instant "haircut" that day. Sorry - GE is one dog that will never go in my portfolio anytime again.



    04:06 pm ET October 21, 2011
Herman Unanski wrote: 
Get rid of Jeff Immelt, and I will think about buying some! How does he survive with his track record of failure? Any other American company would have fired him long ago!


    06:30 pm ET October 21, 2011
Myron Harvist wrote: 
I think the 3 people above hit it right on the head. It's a company like Microsoft - should be doing better, but ain't.


    08:54 pm ET October 21, 2011
Kirk Cornwell wrote: 
We are talking about a company with well over ten billion shares outstanding. The "strong capital position " is a feature of an almost incomprehensibly complex balance sheet. A. prolonged "15%" growth rate is virtually impossible here. Buy on the dip? Maybe. Sell on a pop. sounds wise too.


    02:50 pm ET October 22, 2011
Dana Mauch wrote: 
Stock action would benefit greatly with a 1-2 reverse stock split. 10 billion plus shares outstanding is a little much.


    02:08 pm ET October 24, 2011
David Abel wrote: 
This recommendation is almost too funny. The management of GE under Immelt has been one crisis after another. And as noted above, their balance sheet is almost incomprehensible. Then there is the millstone of GE Capital - that you can always count on for some sort of minor financial disaster every year. Oh - and last but not least - about four years ago GE was a compnay that traded in the mid-$30s - about double what it sells for now.

    October 21st 2011 closing price – 16.31

    12 month forward dividend yield - 4.17%

    Price to book - 1.39

    Trailing p/e – 13.4

    Five year p/e average – 9.95

    Ten year p/e average -10.52

    Forward p/e – 10.59

    Market cap - 172.9 billion

    Revenue Backlog – 191 billion

    Subsequent two and a half month return ( which excludes dividends ) 15.51%

  • Report this Comment On January 14, 2012, at 12:20 PM, plange01 wrote:

    the markets will continue to decline until america elects a president...

  • Report this Comment On January 14, 2012, at 8:10 PM, Merton123 wrote:

    We are in an election year. There will be a lot of volatility but the upward trend will appear. Dollar cost averaging smoothes out the volatility and get the best average price for your dollar

  • Report this Comment On January 14, 2012, at 11:30 PM, fodopost wrote:

    Take a good look at the impressive gains that both U.S. and global stock markets posted in 2011, to many investors’ pleasant surprise. You don’t want to miss the repeat performance in 2012.

  • Report this Comment On January 14, 2012, at 11:36 PM, goalie37 wrote:

    Buffett says that he wouldn't care if the market closed for 3 years, because during that time his companies would continue to generate profits. How many 1.5% plus days occur in a 3 year period? I wish people would understand that staring at a ticker is not the way to succeed in the financial markets!

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