The economy is slowing down--or is it? The Fed is done with monetary
tightening--or it isn't? Tech stocks are rebounding--or are they? With all
the uncertainty, it's no surprise that stock market volatility is running
at unprecedented levels. Right?
Well, it turns out that stock market volatility isn't off the charts from a
long-term perspective. Volatility was higher during the late 1920s and
1930s, as well as during the oil shocks of the 1970s and the 1987 stock
market crash. The sense that volatility is up largely reflects the high
level of the major market indexes. Wild 100 to 200 point swings on the Dow
are commonplace. Yet the changes aren't extraordinary when measured on a
percentage basis. For instance, two out of the top five point increases and
point declines in the Dow were reached in the first six months of this
year. Yet as a percent, none of the daily changes clocked over the past
thirteen years made the record books.
Still, that's not the end of the volatility story. Something is going on
when the stock price of Computer Associates plunges by 44% in one day and
wireless giant Nokia loses a quarter of its market value. Overall market
volatility isn't increasing, but individual stocks are progressively
unpredictable, argue economists John Y. Campbell of Harvard, Martin Lettau
of the Federal Reserve Bank of New York, Burton G. Malkiel of Princeton,
and Yexiao Xu of the University of Texas at Dallas in a recent paper, "Have
Individual Stocks Become More Volatile?"
The rise in individual stock volatility is important for investors. For one
thing, some 10 million employees now own stock options even though the risk
from concentrating a large portion of wealth in one stock is greater than
before. Heightened volatility also means the convention that owning 20 to
30 stocks offers adequate diversification in an equity portfolio is
outdated. Recent research suggests that figure has swelled to 50 or so stocks.
The bottom line: Diversification is more, not less important, in
the new economy.
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