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Don’t be lulled into false security

Updated: May 3, 2013 12:14PM

Originally published: August 7, 2001

This is the week before the Labor Day holiday--a time when many institutional money mangers traditionally take a few vacation days. And that means market volatility is traditionally relatively low.

But it appears we’re creating some new traditions in the new market era.

The consensus vacation time of fund managers doesn’t mean they’re not watching the store. From whatever beach or lawn chair or putting green, they’re connected to the markets by CNBC and a Palm Pilot on a 24-hour basis. And if there is somewhat of a vacuum in big block trades, the individual investor has stepped in to have an even more dramatic impact on market volatility.

While definitions of volatility might change, the numbers tell the story. A 100-point move in the Dow Jones industrial average would have made screaming headlines a decade ago. Today it’s a Breakfast Brief item.

Even if it takes a larger point swing to make national news, it’s not your imagination that these markets are incredibly flighty. In fact, a T. Rowe Price report calculates that day-to-day volatility has been at a historical extreme.

Part of that market volatility comes from the tech-dominated Nasdaq index, which had six of its 10 biggest one-day percentage gains in the second quarter--including a record one-day gain of 7.9 percent at the end of May. But it also recorded four of its 10 worst daily losses during the same quarter.

On a weekly basis, the 25 percent loss for the third week in April was nearly matched by a 19 percent rebound in early June.

In the first half of this year, on 57 percent of the trading days, the Nasdaq composite index showed at least a 2 percent change from the previous day’s close. During the 1990s, that phenomenon occurred only 8 percent of trading days.

It’s not just the Nasdaq that’s making waves. Both the S&P 500 stock index and the Russell 2000 index of small-cap stocks recorded at least a 1 percent difference between the intra-day high and low on more than 90 percent of the trading days in the first half of the year.

Statistics show that 2000 has been the most volatile year for the broad market since 1938, according to T. Rowe Price.

The catalysts for this market volatility have included the current high valuations based on price-earnings ratios and the increasing participation by individual investors, many of whom are day-trading online. Factors in the brokerage industry also contribute to volatility, with many firms limiting the capital they’ll commit to taking positions against market trends.

Whatever the causes, market volatility is a relative concept--just like the weather. What would seem a positively balmy 60-degree evening in January causes us to complain about needing a jacket in August. We grow used to the prevailing climate pattern, and it is shocking only in the absence of what we expect.

In spite of growing market volatility, the overall trend has been up for most of the past decade. Yes, there have been scary moments when it looked like the market was headed south on a permanent basis, but each time there was a rebound. That’s now part of the climate to which we’ve become accustomed.

Just like the dire warnings of global warming--or even global cooling (which might account for a Chicago summer with not one day over 100 degrees)--we feel comfortable with the status quo.

History teaches us that the status is never quo--not permanently. And it’s dangerous to think that way. So don’t let your guard down.

An entire generation of investors has never seen a market that trends lower over a period of a year or two, much less a decade, such as what happened in the 1970s.

An entire generation has never seen a Dust Bowl like the 1930s--and most of America is shocked by the wildfires now burning in the West.

These are events that don’t seem particularly amenable to predictions. Why, our weather forecasters don’t even seem able to accurately predict rain or shine for summer outings and picnics even a few days in advance. No one has an absolute answer to future stock market action, either. But it’s always wise to consider the possibilities.

What hurts you most isn’t what you don’t know. It’s what you think you know, that isn’t so.

And that’s the Savage Truth.

Terry Savage is a registered investment adviser for stocks and commodities and is on the board of directors of McDonald’s Corp. and Pennzoil-Quaker State Co. Send questions via e-mail to savage Her third book, The Savage Truth on Money, recently was published by John Wiley & Sons Inc.

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