The Significance of Recent Stock Market Volatility

August delivered a modestly positive month for stocks, which have been down 7 of the last 11 months since stocks peaked in October 2007.  The first week of September erased those gains and more.  Since July 1st, the stock market has gained or lost 1%/per day 51.0% of the time compared to 12.8% of trading days in the calmer days of 2006.  Even more remarkably, stocks have moved intra-day (high versus low) 1% or more 89.8% of trading days since July 1st, and 2% or more 40.8% of the time.  Stocks were less volatile in 2007 and dramatically less volatile in 2006.

Through Monday night, the S&P 500 was down just 1% on the quarter.  However, worries (real or not) about Lehman Brothers on Tuesday knocked that stock down 44% on the day and down over 50% in the last 5 days.  The stock market was modestly higher at 10AM, but turned negative shortly thereafter, with a decline accelerating into the close down 3.4% and with 7 stocks declining for every one stock that was up.  This was the worst decline for the S&P 500 since February 2007, coming one day after the best rally in a month.  How can bad news about one company, true or not, have such an impact on the rest of the market?

Still a bear market

Part of the problem is that US investors are still afraid of putting money back to work in stocks.  In July, investors pulled $26.4 billion from stocks funds, the biggest outflow since January's redemption of $44.84 billion.  YTD through August 20th, investors withdrew a net $59.1 billion, or 1.5% of total stock fund assets.  This unfortunate behavior of selling when stocks are low, and buying when stocks are high, does not account for the massive increase in volatility, however.  To answer that question, we need to consider how the stock market trading mechanism has evolved in recent years.