Skip to main content
MENU
Subscribe
  • Subscribe
  • Account
  • LOGIN
  • Topics
    • Alternatives
    • Consultants
    • Coronavirus
    • Courts
    • Defined Contribution
    • ESG
    • ETFs
    • Hedge Funds
    • Industry Voices
    • Investing
    • Money Management
    • Opinion
    • Partner Content
    • Pension Funds
    • Private Equity
    • Real Estate
    • Russia-Ukraine War
    • SECURE Act 2.0
    • Special Reports
    • White Papers
  • Rankings & Awards
    • 1,000 Largest Retirement Plans
    • Top-Performing Managers
    • Largest Money Managers
    • DC Money Managers
    • DC Record Keepers
    • Largest Hedge Fund Managers
    • World's Largest Retirement Funds
    • Best Places to Work in Money Management
    • Excellence & Innovation Awards
    • WPS Innovation Awards
    • Eddy Awards
  • ETFs
    • Latest ETF News
    • Fund Screener
    • Education Center
    • Equities
    • Fixed Income
    • Commodities
    • Actively Managed
    • Alternatives
    • ESG Rated
  • ESG
    • Latest ESG News
    • The Institutional Investor’s Guide to ESG Investing
    • ESG Sustainability - Gaining Momentum
    • Climate Change: The Inescapable Opportunity
    • Impact Investing
    • 2022 ESG Investing Conference
    • ESG Rated ETFs
  • Defined Contribution
    • Latest DC News
    • DC Money Manager Rankings
    • DC Record Keeper Rankings
    • Innovations in DC
    • Trends in DC: Focus on Retirement Income
    • 2022 Defined Contribution East Conference
    • 2022 DC Investment Lineup Conference
  • Searches & Hires
    • Latest Searches & Hires News
    • Searches & Hires Database
    • RFPs
  • Performance Data
    • P&I Research Center
    • Earnings Tracker
    • Endowment Returns Tracker
    • Corporate Pension Contribution Tracker
    • Pension Fund Returns Tracker
    • Pension Risk Transfer Database
    • Future of Investments Research Series
    • Charts & Infographics
    • Polls
  • Careers
  • Events
    • View All Conferences
    • View All Webinars
    • 2022 Retirement Income Conference
    • 2022 Managing Pension Risk & Liabilities
    • 2022 WorldPensionSummit
Breadcrumb
  1. Home
  2. Print
October 16, 2000 01:00 AM

Equity valuation in era of rising volatility

Ben Inker
  • Tweet
  • Share
  • Share
  • Email
  • More
    Reprints Print

    Recent times have seen a number of unprecedented events in the stock market. One event that has been somewhat overlooked has been the extraordinary rise in daily volatility in the markets. We have all gotten used to it now, but the numbers are startling.

    From 1971 through 1997, there were 40 days in which the Nasdaq composite index rose or fell more than 3%. In 1998 alone there were 16. In 1999, 20. And this year through Oct. 5, there have been 50 days of 3% or more moves, more than in the first 27 years of the index combined.

    Cross-sectional volatility also has been amazing. From 1985, when our daily data begins, through 1998, the Russell 1000 value and growth indexes had daily moves relative to each other of 2 percentage points or more seven times. In 1999, they had five such moves; and so far in 2000 through Oct. 5, 32 times - twice as many as in all our prior history.

    And the moves do not appear to be in response to unprecedented events. There have been interest rate increases before. Inflationary expectations have risen and fallen far more than anything seen now. But never have we seen such a manic-depressive market, moving from despair to elation and back within a week, and sometimes even a day. So what has happened? What makes today so different from the relatively tame history of stock market returns?

    One factor seems to stand out - valuation. The stock market is priced more highly, relative to earnings or assets, than ever before. That could mean the stock market is overvalued. But let us assume that the stock market is fairly valued and the fact that earnings and dividend yields are low today simply means growth will be higher in the future. Valuation and volatility are still inextricably tied, for a very simple reason: duration. Duration is a concept more frequently associated with bonds than stocks. Basically it is a measure of how long it takes, on average, to get each dollar of income from a security. It is not often mentioned in terms of equities, since the cash flows from stocks are not guaranteed. But they can be estimated. Even if the estimates are imprecise, they do tell an important story. Because as the price of a stock goes up, so does its duration. Historically, the Standard & Poor's 500 has sold at a price-earnings ratio of 15 and a duration of around 30 years. Today, at a p/e of 29, its duration is 61. For Nasdaq, which also has had a historical average p/e of around 15 and duration of 30, the current duration is more than190 because of a current p/e in excess of 100.

    Why should we care about these numbers? After all, they are only estimates, and pretty imprecise ones at that. But fixed-income managers care about the duration of their portfolios because it tells them the sensitivity of their portfolios to a change in interest rates. The longer the duration, the greater the sensitivity. Equity duration tells us the same thing with respect to a change in either the discount rate or the expected growth rate. And frankly, there is little reason for equities to change in value apart from a change in one of those two factors. Given the current duration estimates, we should expect the S&P 500 to be more than twice as volatile today as it has been historically, and the Nasdaq six times as volatile.

    So far this year, S&P 500 daily volatility is running at 1.9 times historical levels and Nasdaq at four times historical levels. Not spot-on the estimates, but pretty close. And given the extraordinary intraday volatility we have seen on the Nasdaq this year - notably a morning fall of 13% one day in April followed by an 11% recovery in the afternoon - perhaps even the daily data underestimate how volatile the market truly has been.

    Something clearly has changed in the markets. Some investors would argue that this daily volatility is irrelevant because we are all in the stock market for the long term. Because there is no evidence (yet) for a rise in long-term volatility, there is no cause for alarm.

    However, such protestations have a problem. One can either believe the stock market is a random walk or that prices are mean-reverting. If the market is a random walk, volatility should rise in proportion with the holding period, and the rise in short-term volatility should mean a similar (and frightening) rise in long-term volatility. Only if the stock market were mean-reverting would this not hold true. However, in a mean-reverting market, higher than average returns are likely to be followed by lower than average returns. So either the market is a random walk and is riskier than it used to be, or it is mean-reverting and due for a big fall.

    Whichever is the case, this is not your father's Nasdaq. Expecting it to behave as if it were may be wishful thinking.

    Ben Inker is director-asset allocation at Grantham, Mayo, Van Otterloo & Co. LLC, Boston.

    Recommended for You
    Read the print edition of P&I
    Read the print edition of P&I
    How low is low? Projections say it's not low enough
    How low is low? Projections say it's not low enough
    FINRA honors Wharton's Olivia Mitchell with Ketchum Prize
    FINRA honors Wharton's Olivia Mitchell with Ketchum Prize
    ESG: Sustainability - Gaining Momentum
    Sponsored Content: ESG: Sustainability - Gaining Momentum

    Reader Poll

    June 6, 2022
    SEE MORE POLLS >
    Sponsored
    White Papers
    Nearing the finish line: Ideas on end-state investing for corporate DB plans
    The Meaning of "Portfolio Intelligence"
    Credit Indices: Closing the Fixed Income Evolutionary Gap
    Forever in Style: Benchmarking with the Morningstar® Broad Style Indexes℠
    Crossroads: Politics, Inflation, & Bonds
    Is there a mid-cap gap in your DC plan?
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today
    June 20, 2022 page one

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    130 E. Randolph St.
    Suite 3200
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Content Solutions
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2022. Crain Communications, Inc. All Rights Reserved.
    • Topics
      • Alternatives
      • Consultants
      • Coronavirus
      • Courts
      • Defined Contribution
      • ESG
      • ETFs
      • Hedge Funds
      • Industry Voices
      • Investing
      • Money Management
      • Opinion
      • Partner Content
      • Pension Funds
      • Private Equity
      • Real Estate
      • Russia-Ukraine War
      • SECURE Act 2.0
      • Special Reports
      • White Papers
    • Rankings & Awards
      • 1,000 Largest Retirement Plans
      • Top-Performing Managers
      • Largest Money Managers
      • DC Money Managers
      • DC Record Keepers
      • Largest Hedge Fund Managers
      • World's Largest Retirement Funds
      • Best Places to Work in Money Management
      • Excellence & Innovation Awards
      • WPS Innovation Awards
      • Eddy Awards
    • ETFs
      • Latest ETF News
      • Fund Screener
      • Education Center
      • Equities
      • Fixed Income
      • Commodities
      • Actively Managed
      • Alternatives
      • ESG Rated
    • ESG
      • Latest ESG News
      • The Institutional Investor’s Guide to ESG Investing
      • ESG Sustainability - Gaining Momentum
      • Climate Change: The Inescapable Opportunity
      • Impact Investing
      • 2022 ESG Investing Conference
      • ESG Rated ETFs
    • Defined Contribution
      • Latest DC News
      • DC Money Manager Rankings
      • DC Record Keeper Rankings
      • Innovations in DC
      • Trends in DC: Focus on Retirement Income
      • 2022 Defined Contribution East Conference
      • 2022 DC Investment Lineup Conference
    • Searches & Hires
      • Latest Searches & Hires News
      • Searches & Hires Database
      • RFPs
    • Performance Data
      • P&I Research Center
      • Earnings Tracker
      • Endowment Returns Tracker
      • Corporate Pension Contribution Tracker
      • Pension Fund Returns Tracker
      • Pension Risk Transfer Database
      • Future of Investments Research Series
      • Charts & Infographics
      • Polls
    • Careers
    • Events
      • View All Conferences
      • View All Webinars
      • 2022 Retirement Income Conference
      • 2022 Managing Pension Risk & Liabilities
      • 2022 WorldPensionSummit