TAKE ADVANTAGE OF STOCK MARKET VOLATILITY
The period since the “Great Covid market crash” of March 2020 has been characterised by a rising market with some volatility in between. Large share price movements up and down have not been uncommon in the close to two years since the last crash as new information becomes available and investors weigh up the fortunes of the global economy. The stock market is said to be forward looking and investors are looking to a normal period beyond the pandemic, but nobody can say for certain when the pandemic will be behind us. This uncertainty is always bound to create volatility which is the topic for this month’s Financial View.
The South African Volatility Index
In 2007 the Johannesburg Stock Exchange (“JSE”) created their first volatility index called the SAVI. The index is designed to measure the market’s expectation of the 3-month implied volatility. The index is based on the FTSE/JSE Top 40 index and is determined using at-the-money volatilities and a volatility skew. The volatility skew should incorporate the market’s expectation of a crash and thus is often seen as the “fear” index. The higher the reading on the SAVI the greater the expectation of negative downside movements in share prices.
The spike in the SAVI in February 2020 coincided with the market crash and since then we have seen sharper movements up and down when compared to the relatively benign index before the crash.
Why volatility is not bad for the astute investor
In a recent previous article, we looked at emotions impacting share prices. The volatility index is a great demonstration of the swings in sentiment. But the changes of investor sentiment are often unrelated to the revenue streams or profits of the company. A company’s business should be unaffected whether Investor A or Investor B is the shareholder, and whether any transaction between them was done at a discount or a premium to fair value. The discount would have resulted where the seller is more desperate to sell and the premium where the buyer is desperate to buy.
The astute investor can take advantage of those opportunities where the share trades at a discount because of a large amount of negative sentiment, despite the fortunes of the underlying company being unaffected.
Warren Buffett famously said that it would be wise for investors to be “fearful when others are greedy, and greedy when others are fearful.” Simply when others are greedy, prices rise and typically boil over, and one should be cautious lest you overpay for an asset that subsequently leads to a lower price and lower returns. When others are fearful, it may present a good value buying opportunity to take advantage of expected higher share price and higher returns when the sentiment changes.
None of us like negative price movements within our portfolios but ultimately there are only two prices that should matter to the investor. The price that you pay and the price that you sell at. Volatility allows you the opportunity to pay a lot less.
Astute investors will welcome bouts of volatility because they see sharp falls as an opportunity to buy a share at a cheaper price. A common complaint among investors goes along these lines: “I really like this company, but the price just seems too high.” Volatility gives such investors the chance to buy previously expensive shares.
Conclusion
Whilst the recent market activity may have you either tearing your hair out or trying to just bury your head in the sand it is not all negative. Large companies tend to remain large companies over many years. Unless the business is fundamentally impaired any short-term pricing pressure should be welcomed by those that have excess funds to deploy. Volatility creates recent opportunities like Sasol at R40 (current price R355) or MTN at R50 (current price R190). Over your lifetime, you can expect to see many market corrections or crashes, these could be seen as an opportunity if you are a buyer or as a crisis if you are a forced seller. At times like these you should have a well-diversified portfolio and enough cash in reserve to take advantage of the opportunity or to sit tight and not be a forced seller.
Recent Comments