Less return for more risk. That’s what the US stock market has been delivering lately. The S&P 500 has just posted its worst 10-year performance in decades. Meanwhile, volatility is its highest since the 1940s.Since 1935, stocks have delivered an average annualized return of 11.3%, using daily data and not including dividends. During that time, however, the market’s performance has alternated between stretches of double-digit returns and periods of single-digit or even negative returns. In 1939, for instance, the 10-year price return for the S&P 500 was at a historic low of -10.0%. Returns strengthened through the 1950s, faded into the stagflation years of the 1970s, and accelerated to new highs through the tech boom of the 1990s before plunging back into negative returns more recently.
Meanwhile, market volatility has followed a different pattern. As seen in the S&P 500’s daily standard deviation and also annualized over 10-year periods, the market’s volatility was as at post-Crash highs in the 1930s, bottomed out in the early 1970s, but then began grinding higher for the next few decades before spiking after the financial crisis of 2008.
Across the grand sweep of history, the relationship between risk and return has been loose and variable. The 1950s was a golden age of high returns and low volatility. Today it is the exact reverse.
The secular rise in stock market volatility remains a mystery. Some experts attribute it to the rise of the hedge fund industry, where assets under management show a remarkable correlation. Others argue that flash trading and other computerized financial innovations are the cause. Perhaps the deeper source is technology itself, in which the dissemination of new ideas has accelerated dramatically, leading to a highly compressed life cycle for business innovation. If so, the waves of stock market performance might also become more compressed going forward.
The anemic performance of the S&P 500 over the past decade has prompted some observers to argue that the market might be in a “new normal” of low expected returns. However, few of even the most bearish forecasters would make the case for negative returns to persist for another decade. As things stand, returns can improve but the not-so-new normal of higher volatility is here to stay.