Too Much or Too Little of Anything is a Bad Thing

Reading Time: 2 mins

Market volatility is the lowest it has ever been in a decade.
Source: S&P 500 Realized Volatility Index. 10 Year Outlook. https://ca.spindices.com/indices/strategy/sp-500-3-month-realized-volatility-index

Volatility has recently reached a low not seen since the 2007 financial crisis. This on initial read may sound really great and may make the stock market an enticing opportunity. You wouldn’t be alone in sharing that sentiment. US and British stocks have been hitting new record highs with increased investor confidence as seen by market volume.

Source: S&P 500 Index Volume. 10 Year Outlook. http://www.marketwatch.com/investing/index/spx/charts

Volatility is ultimately a gauge for market fear/greed. The more volatile the market is the quicker it shifts up or down. But low volatility is also risky. This is because it creates an environment that moves the stock market into overvalued territory. In this kind of environment any new risks that emerge tend to cause a larger than expected selloff, resettling the market back to a more appropriate market valuation.

Carl Richards captures it best in “the psychology of buying high, sell low, repeat until broken”. People tend to buy the high out of greed and then sell the low out of fear of a dropping stock price.

Key takeaway: understand how much overvalued, undervalued, or appropriately valued a company is. Don’t forget to acknowledge thematic market risk while pricing in future expectations for a single equity. Don’t buy the high out of “greed” or “missing out”.

Source: Morningstar Equity Analyst Report (May 3, 2017). Apple (NASDAQ: AAPL).