March 25, 1998

Generally speaking, Wall Street and the financial news media likes to downplay the severity of the current volatility of stocks and the overall market. It is easy to understand why. The more volatile stocks and the market are, the more money made by Wall Street.

Brokerage stocks are doing fantastic because lots of money is coming into the market, but the brokerage stocks are also doing well because of the heavy turnover. Tons of commissions were generated when Wall Street invented the so called Asian crisis last October and there was a heavy sell off, just as many commissions were generated when Wall Street, all of a sudden, decided that the so called Asian crisis didn't really have that much impact on stocks here in America. (Note: no one, but Wall Street has the power to cause a sell off like the one last October, nor does anyone, but Wall Street have the power, in just a few months, to turn right around and drive stock prices to record highs.)

As an informed investor you need to think about all the aspects of volatility and not just the one Wall Street talks about. There are about 10,000 stocks on the NYSE, AMEX, and NASDAQ. As you increase the number of these stocks that are in a certain portfolio, you decrease the overall volatility of the portfolio immensely. This is the volatility that Wall Street talks about, they assume the average portfolio has about 200 stocks in it. The truth is that most individual portfolios have less than 20 stocks and therefore are very volatile. And for those that may own less than 5 stocks even more volatile.

When you look at stocks on an individual basis, the volatility is ridiculous. Just look in the newspaper listings for stocks and look at the highs and lows for the past year. You will see virtually every stock's high and low, including the blue-chips, vary by at least 100% to several hundred percent. For example, 3Com which is a blue-chip technology issue, was $80 a share at the beginning of 1997 only to fall to $30 a share in the Spring. It then doubled to $60 in the Fall and then turned right around and lost half its value to $30 in the Winter. 3Com is no penny stock and it is not the exception, but the norm.

Another issue about volatility that keeps popping up is the higher levels of the major indexes. In the March 30 issue of Business Week there is an article, "The Myth of Stock Volatility." Right off the bat you should be wary of this article. The title says "Stock Volatility," but when you read the article you will find that the only volatility the author is talking about is "major index volatility" which may or may not be the volatility that you care about. Like I said, portfolios range from 1 to several hundred stocks and therefore, volatility also drastically differs.

As far as the volatility of the major indexes go, again, you have to look at all aspects. In the Business Week article, the author asks, "Why do many traders believe that markets are volatile?" "One likely reason is that they haven't gotten used to the higher levels of the major indexes, in which small percentage changes produce big point swings." This is misleading because this suggest that all that matters is percentage. However, a 500 point drop in 1987 when the market was at 2,000 (25% percentage move) was a $500 billion dollar loss and in 1998 a 500 point drop (less than a 6% percentage move) is still a $500 billion dollar loss. Money is money to me and the percentage is less significant. I have no problem with Business Week, if all they are concerned about is percentage that's their business, but if I were you, I would not only look at percentage movement, but real dollar movement too.

Another way of looking at it is that let's say someone invested $10,000 in the mid-eighties and in 1987 the market fell 25% or 500 points, the investor lost 25% or $2,500. Now in 1998, the investor, through additional savings and return has grown their portfolio to $100,000. The market only falls 6% or 500 points, the investor lost 6% of their portfolio, but lost $6,000. Like I said, to me, money is money and even though the loss in 1998 was only 6%, the investor still lost over two times as much money as they did in 1987. If the market loses 25% in 1998 like it did in 1987, the investor will lose $25,000 or 10 times what they lost in 1987.

Make sure that you think about and look at volatility as it affects you and not how its affects Business Week or your mutual fund company, or anybody else on Wall Street.

Return to: Inside the Stock Market