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Staying relaxed about stock markets

Technical Article

Markets are volatile. They move up and down. Always have; always will. Whenever markets fall, commentators concoct stories to explain exactly why they’ve fallen – stories that are often alarming and are frequently complete inventions, with no basis in fact. Usually, it’s best to ignore the headlines.

We have different ways of looking at market movements, that helps us to gain some perspective, block out the noise, and remind us that it’s normal for markets to jump around.

Don’t worry about big daily moves in markets

One way to think about volatility is to look at how often the market moves sharply up and down. The chart below shows the number of large daily moves in a given year for the FTSE All Share, dating back to 1969.

Source: Thomson Reuters. The calendar year is on the horizontal axis, with the total number of days with large market moves on the vertical axis.

  • In the long term, on average, the FTSE All Share moves up or down by more than 1% on 60 days of the year i.e. on nearly a quarter of all trading days.
  • 2017 was notably the calmest year on record. The market moved by more than 1% on only eight days.
  • 2018 has been a normal year so far; in fact it’s been a little quiet in terms of market movements, compared to the average.

This year investors have been focussing on how volatility has been returning to the markets. The above chart gives a longer term perspective; while equity market volatility is definitely higher than last year, 2017 was the outlier year, not 2018.

It’s also important to note that in equity markets, periods of calm aren’t necessarily followed by a storm. 1996 and 2005 were also quiet years for the FTSE 100, but even though it was choppier in the next two years, in each case the market still rose overall.

Don’t worry about big annual moves in markets either

Although investors are sometimes spooked by large one day moves in markets, what really matters is sustained periods of losses. Over the long term equities tend to rise. But the long term is made up of lots of short term periods, so we need to be able to hold our nerve through these.

The chart below shows the maximum peak to trough move of the FTSE All Share each year on the horizontal axis, and the eventual market return in that year on the vertical axis. Each dot is a calendar year – the positive years are in black, with negative years in red.

Source: Thomson Reuters.

  • Every year, the market falls below its peak, at some point. This is a reminder that markets can’t reach new highs every day. Historically, measured on a daily basis, the FTSE All Share spent 95% of the time below its previous peak.
  • The equity market has risen in over 70% of calendar years, with an average return of 16% (stripping out 1975, which was exceptional).
  • The average drawdown during a positive year for equities is -13%. Positive returns have materialised in some cases even where the market was as much as 20% down from its peak during the year.
  • Even in negative years, the final return has usually been a lot better than the lowest point would have suggested. The average market peak-to-trough fall is -26%, but the average return in negative years for equities is only -12%; following market slumps, things usually improve.
  • There are two outlier years that are highlighted on the above chart, for shock value, and also, as a reminder that great years often follow terrible ones.
  • In 1974, the UK was in the depths of a recession, dealing with miner’s strikes, three-day weeks and an oil crisis.
  • The FTSE All Share crashed by 55% in that year.
  • In 1975, as the economy recovered, the FTSE All Share surged by 140%.