What is Volatility?

Volatility isn’t a fun part of investing. As the market grapples with economic turmoil, daily price moves become more erratic. While both upside and downside volatility increase during market pullbacks, it’s the downside that really concerns us and makes for those gut-wrenching days.

Defined as the variation in prices over time, volatility can be measured in a number of academic ways, including standard deviation or beta. Or, as shown below, we can eyeball it by looking at daily price moves. 

Since 1982, fifteen of the twenty most volatile trading days occurred during a bear market, while another three came in the days immediately following the market bottom. The remaining two (which happened in 1997/98) occurred during the Asian crisis – not a formal bear market but a market correction.

It’s interesting to note that many of the twenty worst days for the market happened within a few days of each other, often offsetting one another. March 12, 2020, when the S&P 500 fell -9.5% was reversed the next day when the market climbed +9.3% on March 13, 2020.

Volatility impacts the more economically sensitive sectors and companies the most, with many seeing large price swings during economic downturns. This year, we’ve been on both sides of that coin. We’ve seen big upward jumps in energy names as oil prices broke above $100/barrel. We’ve seen Lockheed Martin’s (LMT) defense business benefit from heightened global tensions on the Ukraine/Russia war.

We’ve also seen portfolio holding Target (TGT) impacted by poor inventory management, trading down from $200/share to $160/share in one session last May. More recently, we saw FedEx (FDX) pull their earnings guidance as freight volumes slowed around the globe. The market rewarded them with their worst daily performance in the history of the company (all the way back to the IPO in 1978).

While we don’t want to downplay the impact of these drops on portfolio values or anxiety levels, we also know they are expected from time to time. FedEx has seen twenty-one daily moves of greater than 10% since 1992, or one about every 17 months. Target has been even more volatile, seeing a 10% move day on average every 14 months. Every year or two, you can expect a day where Target and/or FedEx is either up 10% or down 10%.

Yet, over the last 30 years (1992-2022), both Target and FedEx have easily outperformed the market. FedEx has beat the market by over 1,000%pts, while Target has outperformed by nearly 3,600%pts. This is despite their frequent volatility. The lesson is don’t let short-term volatility cloud the long-term decision on good investments.

While we never enjoy those days when one of our holdings gaps down, we take it as an opportunity. Is this just a short-term setback in a long-term compounding story? Or has something changed in the underlying company fundamentals? Viewed this way, we can use the market’s mood swings to our advantage – adding to positions as they sell-off and exiting positions during euphoric swings. This was what Warren Buffett meant when he said, “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”

While profiting from market folly is great, honestly the more market volatility we can avoid, the better we sleep at night. That is why we often overweight lower risk sectors like Consumer Staples and Healthcare. Historically, both have beaten the market’s return, while also posting lower volatility. See our first quarter 2021 newsletter for more detail.

A focus on dividends also helps to offset volatility. While dividends aren’t guaranteed, most companies treat their payment as sacred. While share prices and account values bounce around, portfolio income via dividends often holds steady or even increases during volatile times (Microsoft increased their dividend +9.7% just this week). While this still doesn’t make volatility any more fun, banking those dividend payments is a nice silver lining.

If you have any questions about your account(s), or if there has been a change in your financial situation or investment objectives, please feel free to contact any member of our team at (406) 839-2037 to schedule a meeting.

Data Sources: Koyfin, Company Filings, Allied Calculations

The views expressed in this newsletter represent the opinion of Allied Investment Advisors, a Registered Investment Adviser. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment or services. The information provided herein is obtained from sources believed to be reliable, but no representation or warranty is made as to its accuracy or completeness. Investing in equity securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results. Investments are not a deposit of or guaranteed by a bank or any bank affiliate. Please notify Allied Investment Advisors if there have been any changes to your financial situation or investment objectives or if you wish to impose or modify any reasonable restrictions on the management of your accounts through Allied Investment Advisors.