Volatility is here to stay — even once we manage the pandemic
[Introduction]
As a Financial Advisor at Scotiabank based in Vancouver, Canada, and over the last couple of months, I have noticed that instead of traditional investing guaranteed investment certificates (GIC) and mutual funds in the bank, clients opt to trade on their own via stocks and ETFs. Specifically, since the COVID-19 pandemic hit the United States and Canada, a growing number of my clients have opted for self-directed accounts to trade and invest themselves. This trend has intensified in recent weeks and has had an interesting impact on US markets. The changes we have seen are primarily due to the impacts of COVID-19 and have resulted in more extreme stock price movements.
[Is there volatility?]
Let’s first look at the data on volatility — has the market actually been unusually volatile? To determine the answer to this question, I looked at the following variables: the S&P 500 over 12 months, and volatility, as measured by the CBOE Volatility Index (VIX).
The S&P 500 has fluctuated between 2400 to 3200 points over the past five years and has fluctuated around an average of 2800 points. As can be seen in the graph below, on Feb 19, 2020, the S&P set a closing record high at 3386.15 points; however, right after the index hit its highest point, it then fell 33.9% in the span of just a month. Additionally, the circuit breaker, the temporary measures that halt trading and are intended to curb panic-selling on U.S. stock exchanges, was triggered 4 times in 10 days between March 9 and March 18.¹ This has been the most volatile period for U.S. stocks since the 2008 financial crisis, according to analysts at Goldman Sachs.²
As a result, the CBOE Volatility Index (VIX ), which measures the stock market’s expectation of volatility based on S&P 500 index options, surpassed 2008 levels and reached 72.98.
So, considering the factors above, there can be no doubt that volatility in the markets is on the rise. The question then becomes: how exactly does the pandemic relate to this volatility? The relationship between this market volatility and COVID-19 becomes clear when we consider the unique situation the pandemic has created: a market steeped in low interest rates, coupled with huge stimulus packages and the rise of trading platforms. These factors led millions of people to participate and invest in the stock market for the first time. In the following, I will outline how each of these factors respectively has resulted in the volatility that we are observing today.
[First-order effects]
The pandemic had two first-order effects that impacted market volatility. First, the pandemic had an economic impact on different industries, which naturally causes volatility to rise. Some industries were struck hard while others flourished. Let’s take a closer look:
Travel and hospitality decreased significantly: Over 40 commercial airlines declared bankruptcy in 2020, and many more are expected to follow;⁴ travel agencies processed more cancellations than bookings, and hotel occupancy rates have fallen greatly in many markets, with employee layoffs and property closures affecting even the largest and otherwise best-performing hotels. One of the most popular high-end hotels — Trump Hotel in Vancouver — closed as the company filed for bankruptcy in 2020. This was reflected in the market: airlines, cruise lines, and hotels all fell significantly. Major players such as United Airline stocks (UAL) alone dropped more than 70% and Carnival Corp (CCL) dropped by more than 80% from late January to March.
On the other hand, tech companies, such as Amazon and Teletech, demonstrated immense stock growth within the same period. Amazon delivered its largest quarter by revenue of all time, generating $125.56 billion in sales earnings in the fourth quarter of 2020.⁵ Further, stock prices (AMZN) are optimistic, having grown more than 100% during the last year.
As the leisure industry solely depends on the economy and demand for services, these markets are largely susceptible to volatility. With COVID-19 and the subsequent government restrictions, those who had demands for such services were unable to travel, which inevitably led the travel industry’s stock to plummet; meanwhile, people heavily relied on online shopping due to stay-at-home restrictions, which led tech companies to gain immense profit and rapidly increase stock prices.
Additionally, the uncertainty created by the pandemic naturally increased market volatility. In the midst of the pandemic, uncertainty increased; people worry about the short-term future, the availability of the vaccine, and the subsequent return to daily life as it was prior to the start of the epidemic. Further, this period has demonstrated great economic policy uncertainty, as well. Research shows that higher economic policy uncertainty leads to increases in stock volatility.⁶
[Democratization of market]
Besides the preceding two factors, a big reason for the uptick in volatility became apparent to me in my professional life: many clients started to open self-directed accounts to trade and invest themselves, therefore increasing volatility further. But why? The unique situation of a global pandemic resulted in a boom in self-directed trading.
[Stay at home rules — investing as leisure activity]
This is certainly due, at least in part, to the implementation of strict stay-at-home rules. During the pandemic, countries around the world reacted to attempt to control the spread of the pandemic by limiting people’s movement. The California state government is currently requesting all residents stay home except permitted work and local shopping. As a result, many people have had time to invest in self-directed platforms that they did not previously have. The app Robinhood has become one of the most popular platforms for commission-free stock trading. As people have had more free time and have been restricted in their social activities in the midst of the pandemic, Robinhood and other comparable platforms have seen immense user growth: In 2014, Robinhood had 500,000 users; by the end of 2020, Robinhood recorded a user base of 13 million people, an increase of 2,500%.⁷
[Fiscal and monetary policy]
Besides strict stay-at-home policies, another crisis response contributed to the substantial increase in trading on Robinhood and comparable platforms: fiscal and monetary policy.
[Fiscal policy]
Stimulus checks often ended up being invested in the stock market. Research shows people earning between $35,000 and $75,000 annually were 90% more likely to trade stocks than the week prior to receiving their stimulus check.⁸
[Monetary policy]
This monetary policy also coincided with loose fiscal policies, with interest rates reaching historic lows. People are no longer satisfied with poor returns in the bank; instead, they opt into investing in the stock market, which can yield quick and high returns.
[Platforms]
And, as new investors became more comfortable with the market, they started investing in seemingly irrational and herd-like patterns. Popular online platforms, such as Reddit and YouTube, gave rise to channels striving to “educate” people about trend stocks, rather than educating people about trading fundamentals. Popular YouTuber Graham Stephan, with over 2.7 million followers, created a thriving donation page to support his YouTube channel. Many blindly follow this advice without doing their own due diligence. This is particularly clear on popular subreddit r/wallstreetbets, which has become increasingly popular among young investors. Because of these channels of advice for new and young investors, trading platforms have seen exponential growth in the last year: Robinhood had more than 600,000 people download its app on Jan 29, a record number of downloads.⁹ As the number of people investing on the market increases, and invertors act irrational, volatility similarly increases.
[Robinhood]
Popular trading app Robinhood soon became one of the primary tools for individual investors who jumped on the GameStop roller coaster, which sent stocks up by more than 14,300% by the end of January.¹⁰
[Gurus]
In addition to the aforementioned platforms to educate investors, the reliance on and reaction to “gurus” on Twitter such as Elon Musk similarly resulted in higher volatility. In January 2021, Musk tweeted a photo of SpaceX and the word “Doge”; as a result, cryptocurrency Dogecoin surged over 50%.¹¹ Coincidentally, when Musk tweeted “On Clubhouse tonight,” the company with the same name saw its stock price explode overnight, rallying around 45%.¹² Nowadays, people invest blindly, investing in what social media and celebrities promote. If investors did more research, they would have known that the Clubhouse app and Clubhouse Media Group are entirely unrelated.
As a result, the rapid growth of self-directed platforms coinciding with loose monetary and fiscal policies led more people to invest on their own course of high volatility. Investors blindly follow social media — as in the case of GameStop or Clubhouse — instead of doing due diligence on stock markets. This new group of investors was responsible for a substantial increase in volatility.
[Conclusion]
In conclusion, we are seeing unprecedented levels of volatility due to the global pandemic we are experiencing now. As many hospitalities file bankruptcy, but tech companies perform extremely well, the uncertainty created by COVID-19 will continue foreseeably into the short-term future, including the uncertainty of availability of vaccines, democratization of financial markets, and investors continuing to blindly “buy the rumor, sell the news.” Therefore, further research into market volatility during the COVID pandemic would be a valuable expenditure. Policymakers should take additional steps when they distribute further stimulus checks, and make sure it does, indeed, boost the social economy instead of being invested in an unhealthy way. Potential new investors would also benefit from an increased number of articles published to educate people not to invest bindly.
By looking at the whole picture, I believe that the volatility created within the last year will outlive the pandemic; a new group of investors has been introduced to the market by the circumstances. COVID triggered the democratization of financial markets, and more and more people started to sign up for self-directed platforms. With many industries beginning to revive, more people are starting to return to the workforce. However, many people are still spending hours on the stock market, and it has become an inescapable part of their new daily routine. Because the government provided stimulus checks to boost the economy, we saw an unprecedented rise of people signing up for trading apps such as Robinhood and following social platforms to trade; with interest rates projected to remain low over the next couple of years, people likely will not change their new behaviors, nor will they soon leave the market. The “new crowd” is likely here to stay, therefore creating a new challenge and environment for the old guard.
Sources
[1] Mejdrich, Kellie. (Mar 18,2020). Stock plunge triggers fourth trading pause in 2 weeks
[2] Doorn, Philip. (March 22,2020). These low volatility stocks have outperformed during the coronavirus crash. MarketWatch
[3] Federal Reserve Economic Data (FRED), S&P 500
[4] Ng, Abigail. (Oct 08,2020). Over 40 airlines have failed in 2020so far this year — and more are set to come. CNBC
[5] Plamer, Annie. (Feb 02, 2021). Amazon reports first $100 billion quarter following holiday and pandemic shopping surge. CNBC
[6] Liu, Li & Zhang, Tao. Economic policy uncertainty and stock market volatility
[7] Curry, David. ( Feb 10, 2021). Robin Revenue and Usage Statistics. Business of Apps
[8] Fitzgerald,Maggie. (May 21, 2020). Many American used part of their cornorvarious stimulus checks to trade stocks. CNBC
[9] Fitzgerald, Maggie. (Feb 01, 2021). Robinhood appears to be benefiting from the trading controversy, seeing record downloads. CNBC
[10] Gonzalez, Oscar& Priest, David. (Feb, 05, 2021). Robinhood backlash: Here’s what you should know about the GameStop stock controversy. CNET
[11] Isidore, Chris. (Feb 04, 2021). Elon Musk tweeted. Then Dogecoin surged more than 50 per cent. CNN Business
[12] Dailey,Natasha. (Feb,02, 2021). Clubhouse stock skyrocketed after Elon Musk tweeted about an unrelated social media app of the same name. Business Insider