It’s still a good idea to sell stocks
Email 
Print
If markets can go up a lot, they can go down a lot. And when an asset class gets more volatile, it gets riskier. Your risk appetite hasn’t changed over the past couple of months, so your appetite for stocks should really have gone down.
Comments RSSPost Your Comment
We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
They say that stocks take the stairs when they go up and take the express elevator when they go down.
This time will be no different.
Volatility is not risk.
They say that if you can’t tell you who the patsy is, it is you. But when I hear someone equate volatility and risk I feel much better about myself as an investor.
You have a complete misunderstanding of volatility. If anything you should sell stocks when the market is not volatile and buy them when the market is volatile. I understand that the models you’re basing your advice on define risk as volatility. But even in those models future volatility is constant parameter and its only realized volatility that is a random variable, due to sampling. Which means, the previous week’s realized volatility should be irrelevant for consideration by the very models you say you’re using. Further, the metric you use to measure volatility, the VIX, is not “the same” as it was on friday. Now I would maintain that volatility isn’t risk and the vix isn’t volatility and that people shouldn’t own stocks to begin with. None the less, on your own terms, your argument is nonsensical.
You are assuming that future volatility has increased — while the VIX might be at high levels, its not certain an investor would accept the VIX is a true measure of future volatility (besides the VIX is down big today contrary to your point). An investor could equally well believe that a spike of high volatility is ending now that Greece has been “taken care of” and would elect to increase their holdings. If you really knew what volatility will be every month for the next 5 years there are much better ways to make money than adjusting equity weights.
The argument to dump stocks based on an expected utility/volatility framework is not going to convince very many people, because that is not how humans think. See Rabin’s calibration theorem — http://www.nber.org/~rosenbla/econ311/sy llabus/rabincallibration.pdf
You would do better to attack the fundamental issues
1) Equity Premium — what will it really be in the future
2) Inflation — or you have to compare equity returns to TIPS returns.
3) Ability of younger individuals to adjust their future consumption to account for investment gains/losses. Personally this is my biggest reason for having lots of stocks. If the market goes up I retire early and take lots of vacations. If the market tanks…. I work longer and make sure not to increase my expenditures from their current level. Since I measure my happiness as changes relative to my current situation, I don’t see a stock market crash as being very negative on my remote future.
This is certainly a topic worth exploring, and I appreciate the fact that you have raised it up for discussion.
I agree with you on some points, but I disagree on a few others. First, I agree that high volatility today increases the forecast of future volatility. If you look at volatility models, like GARCH, and in simplistic terms, future volatility predictions are similar to a weighted average of historical volatility, with the most recent volatility observations receiving the most weight. But as you move out over time, the volatility forecast moves closer to the historical volatility average. It is not a random walk model where the best prediction of future volatility is the volatility today. But my volatility prediction for tomorrow is higher if volatility received a large positive shock today.
Now, my risk tolerance, assuming I am an average 401K investor, who deposits a bit each month into a retirement account, is not based on today’s volatility. It is based on my forecast of future volatility over the life of my holding period. If I am young, today’s volatility does very little to change my future volatility prediction. And if I am old, while it does change my future volatility prediction by a greater amount, presumably I have been moving out of risky assets over time, so any adjustment I make into less risky assets would be small.
There is certainly an argument to be made that because many investors don’t have the discipline required to buy and hold through periods of high volatility, it makes sense for them to avoid stocks rather than buy at the top and sell at the bottom, but if one is following the traditional 401K risk-adjusted-for-age advice, then high volatility today shouldn’t require significant portfolio rebalancing.
Felix, Thanks for your insightful comments. Some individuals commenting here state the incorrect as a fact (such as “volatility is not risk”) – when a simple Google search would clear up their confusion. In the end, models can only go so far, and an individual’s tolerance for risk should be key to if/how much someone should be invested in equity.
To me, and to many successful investors, risk is the chance of experiencing a permanent loss of principal. Risk to me is owning an overvalued asset because if it is at above its intrinsic value I may permanently lose capital when it reverts toward its true value. This is true of government bonds too if they are overvalued. Volatility in government bonds is much lower than in stocks but in an accelerating inflation environment bonds can actually be riskier.
Of course what I just said makes no sense to efficient market clowns. I have been an investor in medium-sized oil stocks (now giants, glory be!) for about a decade. It has been a very choppy (volatile) ride upward.
Would it have been less risky to own Microsoft for the last decade since as a giant Fortune 5 or 10 company it was less volatile? No, it would have been riskier to own MSFT in 2000 since it was overvalued, and I would have lost money over the intervening decade.
For those who wish to keep equating risk and volatility by all means continue to do so. Your losses will be our returns.
Dan Hess is right. I forget which economist it was that always says he realised something was going very wrong in the 2000-era financial markets when he heard someone say that the definition of risk was “volatility about a central tendency”. The VIX is an index of option premium, not of volatility and since the one thing we know about realised volatility is that it is mean-reverting and serially correlated, it doesn’t seem to me that it makes a lot of sense to condition your overall investment strategy on the current level of the VIX.
But the bottom line here is that if you’ve made a big sell call two days before a massive rally, you really need to be a bit diffident. And definitely watch out for phrases like “the reason to sell stocks wasn’t that they were going to go down” and “they were at high values, now they’re even higher” – blatant tape-fighting like that is presumably how people like Larry Kudlow started the process that led them to where they are today.
I’d also calm down with the hand gestures mate.
This isn’t just a little volatility, there is a sense that the systems of the last few decades driven by Thatcher and Reagan are now through their cycle in which public wealth was sold off by corrupt politicians, promising the invisible hand would guide us to safety.
Now that the invisible hand has dug as deep into our pockets as it can we are shifting to a more pragmatic view of what is public and what is private, as the current model of profits being private and losses being public has resulted in fewer with wealth and less real growth in the economy. All of the wealth created in the market has been on the back of velocity, counting the same dollars as they are thrown around the world by algorithms created by the next infamous quant that could and then couldn’t.
Regulations in banking, finance and energy came about for reasons we forgot, now we need to reestablish the operating agreement between tax payers and organization men so that there $61 million pay days are decreased and proper balance of risk and reward is established to limit the large failures and small costs that have eroded real businesses under these bankrupt “conservatives” policies.
I think this was one of the most enjoyable contributions on Reuters that I have seen for a while. Especially because a lot of people who know a lot about the markets have responded to it and I have learned a lot. However, one little issue that I can’t get over (and that’s why I think it might be a good idea to get out of stocks for the moment) is that everyone seems to think all the public debt has just disappeared overnight after the EU has decided on a plan to help heavily indebted countries. I understand the psychological effect these measures have had and I am greatful for it. We might have been in for a total economic meltdown otherwise. But the real work, the painful part, is still ahead of us, and stock exchanges all over the world are by now definitely way ahead of reality again(!). Whatever the VIX says, it should be through the roof.