Volatility - Good or Bad?

"Well you see Norm, it's like this. A herd of buffalo can only move as fast as the slowest buffalo.  And when the herd is hunted, it's the slowest and eakest ones at te back that are killed first.  This natural selection is good for the herd as a whole, because the general speed and health of the whole group keeps improving by the regular killing of the weakest members.  In much the same way, the human brain can only operate as fast as the slowest brain cells.  Now, as we know, excessive intake of alcohol kills brain cells.  But naturally, it attacks the slowest and weakest brain cells first.  In this way, regular consumption of beer eliminates the weaker brain cells, making the brain a faster and more efficient machine.  And that, Norm is why you always feel smarter after a few beers." - Buffalo Theory as explain by Cliff Clavin of the television show Cheers.

As we have all noticed the volatility in the stock market has increased dramatically in October.  At one point the market had fallen more than 8% in less than a month and yet today it appears that the rally is still intact.  With one day down the next up and most days with moves of more than 1% it is enough to scare anyone, the question then is what is this volatility telling us and is it good or bad?

Life is full of volatility; the daily ups and downs not to mention illnesses from which you recover or challenges that cause stress all normally result in a stronger individual both physically and mentally.  Some time the volatility is so intense that the person never recovers but these cases are relatively rare.  In general the human race has evolved by taking on the challenges of volatility, learning from these challenges and becoming stronger.  As 21st century humans our bodies are immune to many diseases that killed many people in the early 1900's simply because nature passes along the antibodies from previous generations.  Furthermore the volatility caused by new diseases has resulted in many medical breakthroughs along with significant improvements in cleanliness and treatment processes so for all intents and purposes volatility in nature is a good thing.

Turning to the economy it is human nature to try to smooth out volatility.  The Federal Reserve is hell bent on giving businesses a smooth ride and making sure that everyone has jobs all the time.  This goal unfortunately has the side effect of increasing the volatility.  Certainly there are periods when volatility remains under control but this provides a false sense of security.  During these periods businesses and individuals assume that the smooth ride will continue forever and invest accordingly.  Risk is perceived to be insignificant so ever larger bets are made based on the false perception.  For this reason when the dam wall breaks there is an increased level of volatility for which hardly anyone seems to be prepared.  The lack of preparation creates significantly more volatility as companies and individuals are forced to exit investments en mass creating a route that is far larger than it would have been had the market been left to its own devices in the first place.

By removing the normal levels of market volatility there is increased stress on the system and hence there are major market collapses.  Given the mantra of central bankers across the globe to erase volatility and given the large amounts of money being pumped daily into the globe by central bankers in an effort to calm volatility it is clear from the recent market gyrations that not all is healthy and that we may be in for a long period of turmoil.  One thing that you can bet on is that the authorities are not going to stand aside and let volatility rear its ugly head without trying another futile round of quantitative easing.  They will return with a "new" quick fix program, one that will create a bigger explosion at the end of the line.

For now however enjoy the fact that the United States markets are (at least for the moment) being left to their own devices and as you can see lower may be the order of the day.  That said I would not be surprised to see the Federal Reserve step in once more if we enter a proper correction which is a mere 5% lower from here.  The problem is that this support is futile and does not provide jobs but will create an even larger problem in the years ahead.