It’s amazing that people will pay good money to be scared out of their wits on a thriller-ride roller coaster, and some of the ride experiences seem to be over the top. Check out this coaster experience in China:
Participating in the investment markets is sometimes described as riding a roller coaster, and the analogy is not far off base. The more the market lurches, the scarier it is, and the greatest fear is generated when the portfolio suddenly takes you over a steep decline. What makes the analogy even more apt is the way investment charts are normally presented, with the price bouncing up and down each day.
But the third quarter of this year took the experience to a new level–to a degree that even some of our professional colleagues haven’t yet completely realized. Look at the two charts below; the first tracks this year’s price movements of the most basic stock market index, the Standard & Poors 500 index of larger U.S. companies. The ride was proceeding nicely, perhaps a little bumpily, until toward the middle of the summer, when large cap stocks suddenly went into a free-fall comparable to the Tower of Terror at the Disneyland theme park. After that, the trip was incredibly bumpy both up and down, making it treacherous for anyone who was trying to trade out of a downturn (missing all those sudden updrafts).
The second chart shows the VIX index, which simply measures how volatile the S&P 500 is at any given time. Higher numbers indicate a bumpier ride, and you can see that the third quarter was remarkably more volatile than the first half of the year.
How long will our present volatility continue? Probably not forever; history shows that the herd of investors gets spooked, then calms down a bit, then gets spooked all over again with surprising regularity. This last graph shows the movements of the VIX since inception in the summer of 2007; the spikes look almost like a slightly-irregular heartbeat, with the big one coming in the last three months of 2008, followed by scary bumps in the roller coaster in the summer of 2010 and the quarter just ended.
This graph may or may not give us a window into the future–the next heartbeat will be unpredictable. But if the past is any indication, just like the rides at the local amusement park, the markets will take us through some smooth periods, and then suddenly give us a good scare all over again. This is the perverse nature of the investment markets; they scare the heck out of you, as if they’re trying to convince you to jump off the ride, and then they provide an unexpected period of nice returns to those few who were brave enough to stay on the track.