Stock market returns and volatility


Active fund managers frequently complain that stock market volatility is too low for their liking and express their preference for more volatile markets. When the stock markets collapse, they can keep their cool and get on with their work. Panic-mode retail investors should present plenty of opportunities to generate alpha.

And indeed, if we analyze data from S&P SPIVA on the underperformance of US domestic fund managers during the Global Financial Crisis (GFC) in 2009, only 41% underperformed their benchmarks, which was the lowest percentage in the last 15 years. Sadly, 65% underperformed in 2008, the GFC’s first year, and 57% in 2020, when COVID-19 hit.

It appears that active fund managers are unable to fully exploit times of crisis, perhaps because they panic like all other investors. Volatility tends to cluster and it may be wise not to trade too much when volatility is high. Investors may need to avoid exposure to equity markets altogether when volatility is high.

In this research note, we will explore the relationship between stock returns and volatility.

Market returns when volatility was high

We focus on six stock markets, namely United States, Japan, Germany, Hong Kong, United Kingdom and Singapore. The data history varies for each of them and goes back the furthest for the United States. First, we calculate the volatility of each stock market using an expanding window. For example, in the United States, we consider all the daily returns since 1926 to determine the volatility of the top quartile in 2021. Then, we separate the daily returns based on when the volatility was high, defined as the top quartile, and as long as it was average or weak. .

We observe that the average daily returns of the six stock markets were positive over the different time periods and that the magnitude of the returns was similar whether the volatility was high or not. Based on these results, there is no reason why investors should avoid exposure to stock markets when volatility is high.

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