Has stock market volatility decreased over the last two decades?!

Published: May 14, 2021 at 11:12 am

Last Updated on December 29, 2021 at 6:14 pm

Suresh Padmanaban writes, “Dear Pattu, I have been investing in the markets since the mid-90s. I get a feeling that the volatility over these years has gradually come down. Can you please quantitatively verify this?” On 3rdf Feb 2021, the Sensex closed above 50,000 for the first time. We studied the evolution of stock market volatility over the last 42 years and found that the cumulative volatility has gradually come down for the Sensex.

Cumulative volatility is the standard deviation of daily returns over time. The maximum volatility for the Indian markets was around the Harshad Mehta scam (early 1990’s) and for the US markets during the great depression (1930’s). Since then the daily volatility has indeed been gradually decreasing as Suresh suspected.

For the US, the standard deviation in monthly prices calculated every possible 10 years peaked during the 1930s but has been more or less the same then! This is quite remarkable and counterintuitive when you stop and think about it. In India, we barely have enough historical data. The five-year rolling volatility has decreases constantly. The Harshed Mehta crash was the highest, the dot com crash was much lower and the 2008 crash in between. The March 2020 crash was a mere blip for the US markets and significantly lower for the Sensex.  The full report is available here: Sensex at 50,000 – lessons from the 42-year journey

In this article, we shall approach the titular question from a different angle. We shall consider a systematic monthly investment over 15 years into an asset allocation of either 70% equity or 50% equity and the rest in debt.

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The NSE 500 TRI will represent “equity” and the I-BEX gilt index will represent “debt”. The portfolio will be rebalanced once every 12 months. We will consider 137 15-year periods from Jan 1995 to May 2021. Please note, this is just a smattering of data and one should not rush to conclusions based on this. A similar study performed with the US markets would yield ten times more data! See: This “buy high, sell low” market timing strategy surprisingly works!

The results for 70% equity and 50% equity are presented below.

  • Top left: The XIRR (annualized return) for the 137 runs are shown
  • Top right: The max fall from an all-time high (of the portfolio value)

For example, shown below is one of the 137 runs (the most recent one). The fall from the peak is shown on the right (drawdown). The max drawdown (or the longest stalactite) is selected from this.

Growth of the portfolio over 15 years with drawdown shown in the right vertical axis
Growth of the portfolio over 15 years with drawdown shown in the right vertical axis
  • Bottom left: The standard deviation of the monthly change in portfolio value. The monthly returns for one of the runs are shown below.
Growth of the portfolio over 15 years with monthly returns shown in the right vertical axis
Growth of the portfolio over 15 years with monthly returns shown in the right vertical axis
  • Bottom right: The no of continuous months the portfolio was below its previous maximum. This corresponds to the widest drawdown stalactite.

The results are compiled below. We recommend that readers inspect the graph for a bit to appreciate the results.

Duration 15Y Equity Allocation 70 percent
Duration 15Y Equity Allocation 70 per cent
Duration 15Y Equity Allocation 50 percent
Duration 15Y Equity Allocation 50 per cent

For the period studied, XIRR (annualized returns) has decreased. See: What return can I expect from a Nifty 50 SIP over the next 10 years? And Do not expect double-digit returns from Nifty Next 50 index funds!

The volatility has decreased, the drawdowns have decreased (become less negative) and the number of months the portfolio was underwater has decreased. The wave-like pattern in the lines is because of rebalancing. We shall update the effect of not rebalancing in a future article. This has been studied before: When should I rebalance my portfolio?

So what does this mean? Suresh is right. Equity investing has got a little “easier” over the last two decades. However, this does not mean it would get even easier in future or the volatility would stabile (become range-bound) like in the US. So it would be better to imagine that the Indian stock market has “stabilized” since the 90s with domestic institutional support rather than become easier. Our market history is too short to make inferences.

We shall conclude with the updated chart for US data (details of the study are linked above) for comparison.

S and P 500 data with 15 duration and equity allocation 50 percent
S and P 500 data with 15 duration and equity allocation 50 percent

Notice the cyclic nature of the returns. The Indian market has possibly seen just one arm of a cycle. Notice the strong dominance of the 1929 stock market crash in the volatility graphs. The volatility is range-bound (at least relative to the great depression years) and the returns have always been cyclic.

What return should an investor in the US market expect over the next 15 years? The honest answer, “no one knows” (even if we assume over 15 years USD-IND returns would be about 4-5%). See: Motilal Oswal S&P 500 Index Fund: What return can I expect from this? And Do not expect returns from mutual fund SIPs! Do this instead!

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Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
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