The month of March 2020 saw heightened volatility in the equity markets, something that we have not witnessed for many years. There were two major things that happened in March:
- Sharp fall from the recent market high
- An increase in daily volatility
What is so unusual about this? Aren’t stock markets supposed to be volatile? Aren’t market falls natural?
Yes, market falls are natural and volatility is the nature of the stock markets. It is the magnitude of both the recent fall as well as the speed of the same that was not seen by most investors in the last decade. Ditto for daily price changes. Let us discuss both below:
The fall of over 30% from the top
Since 1980, there have been seven instances of the Sensex value dropping by more than 30% from the top including the current one. The last such instance prior to 2020 happened in 2008. Here is the list of all the instances when the first time the Sensex value dropped by more than 30% from the peak value:
|
1st drop of >30% |
New high |
||||
|
Sr |
Date |
Value |
Date |
Value |
No. of days to recover |
|
1 |
05-May-87 |
455.13 |
30-Sep-88 |
662.71 |
514 |
|
2 |
19-Dec-90 |
1,058.41 |
26-Jul-91 |
1,599.98 |
219 |
|
3 |
12-May-92 |
3,086.37 |
12-Aug-94 |
4,508.15 |
822 |
|
4 |
22-Feb-95 |
3,233.31 |
14-Jul-99 |
4,710.25 |
1603 |
|
5 |
12-May-00 |
4,107.15 |
02-Jan-04 |
6,026.59 |
1330 |
|
6 |
20-Jan-08 |
19,013.70 |
04-Nov-10 |
20,893.57 |
1019 |
|
7 |
18-Mar-20 |
28,869.51 |
? |
? |
|
(Source: www.bseindia.com and Karmayog Knowledge Academy)
Heightened daily volatility
The following table shows daily movement of Sensex in the month of March 2020.
|
Date |
Sensex close |
Change in value over previous close |
|
02-Mar-20 |
38,144.02 |
-0.40% |
|
03-Mar-20 |
38,623.70 |
1.26% |
|
04-Mar-20 |
38,409.48 |
-0.55% |
|
05-Mar-20 |
38,470.61 |
0.16% |
|
06-Mar-20 |
37,576.62 |
-2.32% |
|
09-Mar-20 |
35,634.95 |
-5.17% |
|
11-Mar-20 |
35,697.40 |
0.18% |
|
12-Mar-20 |
32,778.14 |
-8.18% |
|
13-Mar-20 |
34,103.48 |
4.04% |
|
16-Mar-20 |
31,390.07 |
-7.96% |
|
17-Mar-20 |
30,579.09 |
-2.58% |
|
18-Mar-20 |
28,869.51 |
-5.59% |
|
19-Mar-20 |
28,492.07 |
-1.31% |
|
20-Mar-20 |
29,915.96 |
5.00% |
|
23-Mar-20 |
25,981.24 |
-13.15% |
|
24-Mar-20 |
26,674.03 |
2.67% |
|
25-Mar-20 |
28,535.78 |
6.98% |
|
26-Mar-20 |
29,946.00 |
4.94% |
|
27-Mar-20 |
29,815.59 |
-0.44% |
|
30-Mar-20 |
28,440.32 |
-4.61% |
|
31-Mar-20 |
29,468.49 |
3.62% |
(Source: www.bseindia.com and Karmayog Knowledge Academy)
This is something most of today’s investors would be very unfamiliar with. While the fall on March 23 was the sharpest ever in the history of Sensex, the daily movement of such magnitude is also not seen in a while.
How often have we witnessed daily movement of more than 4% (in either direction, i.e. 4% up or 4% down)?
There have been 130 moves of 4% or more on the upside and 125 moves of a similar magnitude on the downside from January 2, 1980 to April 3, 2020. That makes it a total of 255 such daily changes out of a total of 9,263 trading days. In other words, such massive changes were seen on 2.753% of trading days, or once every 36.33 days.
Compare that to the previous decade, i.e. from January 2010 to December 2019. There were 2,454 trading days, out of which there was 1 day with a more than 4% upside, and 2 days with more than 4% downside in terms of Sensex movement. That makes it 0.122% or a bigger than 4% move happened once in 818 days during the decade. Even when we count the number of days with 3% or bigger daily Sensex movement, it happened on 19 occasions, or the frequency of that was once in 129 days – roughly once every 4 months.
The entire decade exhibited low volatility. It was a sort of a situation that made people believe that we have entered a new era.
- Those who entered the stock markets after 2009 had not seen too much volatility, whichever way you want to measure – a steep fall, or large daily movements
- Some of those who had seen the earlier phases of volatility might have started believing that the timers have changed and volatility is a thing of the past
Both these remind us of the story of elephants being tied by a small piece of rope, which is reproduced below for a quick reference:
A man was walking through an elephant camp. He was surprised to see that the elephants weren’t kept in cages or held by chains. All that was holding them back from escaping the camp, was a small piece of rope tied to one of their legs. As the man gazed upon the elephants, he was completely confused as to why the elephants didn’t just use their strength to break the rope and escape the camp. They could easily have done so, but instead they didn’t try to at all. Curious and wanting to know the answer, he asked a trainer nearby why the elephants were just standing there and never tried to escape.
The trainer replied: “When they are very young and small, we use the same size rope to tie them. At that age, the rope is enough to hold them and they do not have enough strength to break it. As they grow up, they are conditioned to believe that they cannot break away. They continue to believe that the rope can still hold them, so they never break free.”
The only reason that the elephants weren’t breaking free and escaping from the camp was because over time they started to believe that it just wasn’t possible to do so.
Compare the above story with the decade long period of low volatility. It is natural for some to start believing that equity, after all, is not so volatile. When that happens, the risk of equity appears to be low. When the apparent risk is low, we have a tendency to lower our guards. When that happens, risk makes a quiet entry.
That is where the month of March 2020 makes a quiet entry.
What happens in such a situation?
The management world discusses a phenomenon known as “frog in the boiling water.” While they use this in the context of change management, it applies to many other areas, including the stock market volatility. The concept goes like this:
If you put a frog in boiling water, it will jump out of it immediately. It cannot bear the heat of the water and hence reacts fast. However, if you put the same frog in water at room temperature, slowly heat it up and gradually raise the temperature to boiling point, the frog will continue to swim in the water until it dies – a slow death. The gradual change leads the frog to death but it can respond quickly to a sudden change.
Volatility of stock prices is like boiling water – if you put the frog in boiling water, he jumps out. Till the time the water temperature was increased slowly, the frog was ok – this is akin to the low volatility situation of the previous decade. The moment a frog was thrown into boiling water, it jumped. That was the month of March 2020.
The frog in this case could be equated with human mind. Investors get scared of the wild price fluctuations, or the heightened volatility. Due to this, they either run away from equity investing or borrow and buy stocks. In other words, the strong emotions of greed and fear take over and the investor starts to act irrationally. An advisor needs to calm the investor and explain that this is indeed the nature of the equity markets. Prices move up and down, and often sharply.
But what about the investment advisor? Does he maintain his calm or does he also start jumping? Does the advisor also get overwhelmed by the emotions? For an advisor to be able to calm the nerves of the investor, it is important to cool down himself, first. In order to do that, the advisor must be totally convinced about what to expect from an equity portfolio.
Amit Trivedi is the Author and Trainer. The views expressed in this article are solely of the author and do not necessarily reflect the views of Cafemutual.
