(PUB) Investing 2016

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The Independent Adviser for Vanguard Investors • August 2016 • 5 FOR CUSTOMER SERVICE, PLEASE CALL 800-211-7641
“The future is more uncertain today.”
“Stocks are more volatile than they
were.”
THIS IS WHAT SEEMS to pass for com-
mon wisdom on Wall Street these days.
And it’s repeated on Main Street as
well. Almost daily, Dan and I hear from
investors who are skittish about invest-
ing in the stock market. And these are
often the reasons they give.
But how do these generally accepted
beliefs hold up under examination? Not
so well.
We can’t quantify uncertainty. But
I’d argue that the future is no less clear
today than it was a week ago, a year
ago or even five years ago.
We all suffer from hindsight bias,
which is the tendency to see a past event
as having been predictable, even though
few people at the time actually saw it
coming. Looking back, the credit crisis
and the bursting of the housing bubble
appear to be the obvious outcomes of
all the subprime lending that we are
now so familiar with. But before those
events, the prevailing belief was that
home prices don’t fall across the coun-
try in unison, and even the likes of then
Fed Chair Ben Bernanke thought the
effects would be contained. The future is
always uncertain, because, well, it hasn’t
happened yet!
I’m sure at this point you are think-
ing, “But wait, the Brexit vote makes
things more uncertain, right?” Well,
yes and no. On the one hand, before the
vote, all the uncertainty was limited to
one question (will they, or won’t they?)
and had a fixed end date (June 23)
when we’d know the answer.
Now that the vote is behind us, how-
ever, there are a whole host of questions
that have replaced one uncertainty with
several. For instance, when and how
will the U.K. leave the EU, and what
does this mean for the long-term viabil-
ity of the EU? Will the pound sterling’s
devaluation stick? Does London lose its
luster as a financial capital?
Yes, that sounds like more uncer-
tainty. However, you could argue that all
those questions were relevant before the
vote, and now we at least know the U.K.
is leaving. Plus, if the U.K. had voted to
stay in the EU, the media’s focus and
investors’ questions would’ve circled
back to any one of the other concerns
out there—negative yields, the U.S.
election, terrorism, China, you name it.
Rather than getting caught up debat-
ing whether the world is more or less
uncertain since the Brexit vote, can we
agree that uncertainty existed before
the vote and persists today?
As I said, we can’t quantify uncer-
tainty—but volatility is another matter
entirely. The VIX, or fear gauge, is a
common measure of volatility that you
may hear about in the press. The chart
above of the VIX over the past five years
shows that volatility was high at the start
of 2016, but then fell meaningfully until
the Brexit vote, which sent volatility rac-
ing. (A great example of what can happen
when everyone is certain of an outcome
that doesn’t play out.) However, the VIX
quickly settled down, and for the year has
averaged 17.4, which is below its long-
term average of 19.8. For much of the
past five years, volatility, by this measure,
has actually been below average.
But the VIX measures expected vola-
tility over the coming 30 days. What
about the volatility we have actually
experienced? The second chart above
shows the standard deviation of returns
of the S&P 500 index in each calendar
year since its 1957 inception. (Standard
deviation is a measure of how dispersed
returns have been. A low standard devia-
tion indicates that returns tended to be
close to the average return. A higher
standard deviation means returns are
more spread out.) Since its inception, the
S&P 500 index compounded returns at
a 6.8% annual pace—note this is price
return only—with a standard deviation
of 15.8%. This means that two-thirds of
the time, the 12-month price return of
the index was between -9.0% and 22.5%
(or the annualized return of 6.8% plus or
minus the standard deviation of 15.8%).
So far in 2016, the standard devia-
tion of the S&P 500 has been 15.3%,
which is actually a touch lower than
average—not exactly an unusual level
of volatility. In fact, as we saw with the
VIX, for most of the past five years,
volatility has been lower than average.
Stocks may indeed be too volatile for
many investors—that’s why most of us
own a mix of stocks, bonds and cash—
but to say that stocks are more volatile
today is false. And if you’re waiting for
market volatility, however normal it is,
to disappear or even to fall to some low,
low comfort level, well, not only will
you be waiting for a very long time, but
when that moment of clarity and calm
arrives, your best investment opportu-
nity may be gone. n
MYTHS
Are Stocks More Volatile?
VIX at Normal Levels
7/11 1/12 7/12 1/13 7/131/14 7/14 1/15 7/15 1/16 7/16
10
15
20
25
30
35
40
45
50 VIX
Avg. Since 1990
Stocks Are NOT More
Volatile Today
196019641968197219761980198419881992199620002004200820122016
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
Standard Deviation
Long-Term Average