Stop Saying Volatility Is a Bad Thing

A change of conditions.

Photographer: Brendon Thorne/Getty Images

Hardly a day went by in 2017 without some pundit bemoaning the lack of volatility in financial markets. They worried about complacency, implying that the Goldilocks-like environment that enveloped markets was a recipe for disaster. With volatility on the rise, you would think the handwringing would diminish. It hasn't. Now, the pundits are worried the big swings in asset prices of the last few months portend doom.

The simple fact is the recent swings are closer to what is considered normal, and investors should be thankful. What happened last year was abnormal. Rising volatility will lead to a healthier market. No longer will everyone be on the same side of every trade, taking the same bet that an individual stock or an index will go up or down. That should result in better "price discovery," which is a fancy way of saying greater differentiation in the values between good and bad stocks.

A primary complaint about low volatility was that it favored the rise of passive investing strategies such as exchange-traded funds, which try to mimic the performance of indexes and don't reward strong companies or punish those that are weak. By one measure, total assets in index funds and ETFs have soared to $6.6 trillion. The spread of this blind approach to investing led the analysts at Sanford C. Bernstein & Co. to publish a research report in 2016 with the title "The Silent Road to Serfdom: Why Passive Investing is Worse Than Marxism." They wrote that "a supposedly capitalist economy where the only investment is passive is worse than either a centrally planned economy or an economy with active market led capital management."

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