Volatility as a factor

This analysis presents an uncanny relationship between stock market performance and the volatility of the market. 

We do not assert a causal relationship; rather, the coexistence of the relationship implies that many measures of risk actually compound in declining markets. 

By contrast, the reward-to-risk relationship improves significantly in strong markets. In the context of secular bull and bear markets, this relationship further emphasizes the need to consider risk as well as reward in an investor’s investment decisions.

This graph reflects a measure of stock market volatility-the statistical standard deviation of monthly changes for the S&P 500 Index. 

The line on the graph reflects volatility for each trailing twelve-month period starting in January 1951 and continuing with each month to present.

There are several insights from the graph.

First, volatility is volatile; it cycles erratically over time. 

Second, periods of extremely high or low volatility often follow the other. 

Third, volatility tends to spend most of its time around the average (i.e., within 25% above or below the average).

High or rising volatility often corresponds to declining markets; low or falling volatility is associated with good markets. 

The current period of low volatility is a reflection of a good market, not a predictor of good markets in the future.