Market volatility and the unbottling of ‘turning points’

Claret was $14.99 in the 1990s but if your tastes have matured then a top-shelf shiraz will cost you closer to $500 in 15 years.

When I worked in derivatives trading in the early ’90s, one of the accepted truths about market behaviour was that “volatility picks up around turning points”.

It was, for example, wise to be alert to the possibility of a large move lower if volatility emerged after a long rally. And while it has been my experience that volatility does indeed cluster around major turning points, it’s possible I only remember what I want to.

However, a quick analysis of the most volatile days in the S&P 500 since 1988 dispels any concerns about selective memory or unconscious bias. Of the 25 largest single-day up moves and the 25 largest daily down moves, almost all cluster around the major turning points in the market, such as the global financial crisis, Covid-19, the tech wreck of the early 2000s and the market lows in 1998, 2011, 2018, and most recently 2022.

Volatility rises at intermediate market highs and lows due to a conflict between bullish and bearish investors. At new highs, optimists argue with the bears, who invariably describe the market as overvalued.

At or near market lows, pessimism clashes with value-seeking investors and those investors hopeful of a rebound.

Notably, current market activity can be described by its significant surge in volatility, suggesting major stock indices might be on the cusp of a turning point. This recent development is of immediate interest to investors and traders, and you might expect me to offer a prediction about what might happen in markets next.

While my prediction for equity returns for the remainder of the year and most of 2025 remains positive, the next point I’m about to make is likely not what you predicted.

The discussion about volatility is, and perhaps should be, completely irrelevant to a large number of investors, especially those nearing or in retirement. Why? Alternative funds now exist that offer returns commensurate with equity markets without much volatility. Some funds, like those Montgomery distributes, have delivered historical returns of almost 10 per cent per annum with zero volatility.

Financial experts tell us that as we grow older and wiser, we should aim to reshape our portfolio towards more income, along with less volatility and, therefore, less risk. Traditionally, reducing volatility meant reducing the exposure to those assets that offered the best potential growth. But rejecting growth at any age is a patently bad decision because it almost guarantees a loss of purchasing power.

Think of it this way: This weekend you will enjoy a bottle of Penfolds St Henri shiraz with friends. Back in the early ’90s I was buying that wine – it was a claret back then – for $14.99 a bottle, a price I was happy to pay in my mid 20s.

Today, 30 years later, that same wine is $150 a bottle, representing inflation of 8 per cent per year. If you are celebrating your retirement at 65 this weekend with a bottle of St Henri, and you enjoy it so much that you hope to celebrate your 80th birthday in 15 years with a bottle of St Henri, you will require $474 to do it.

To maintain your “St Henri” purchasing power, you need your wealth to rise by at least the same amount as the price of that bottle of wine.

Of course, the example of a consumable I have shared is wine, but it can be any other item or items you consume today and want to continue to enjoy through retirement.

Typically, growth assets like shares are required to perform the task of “purchasing power preservation” because, given enough time, the market value of shares follows the performance of the underlying business.

If a business is generating a sustainable 15 per cent return on a shareholder’s equity and that business pays 50 per cent of the return as a dividend, the market value of the shares should eventually track the increasing value of the company, which is rising at 7.5 per cent per year.

Of course, the share price won’t rise by 7.5 per cent every year – more on that in a moment – but in theory, the market value over the long term should rise at an average rate that approximates the increase in the value of the underlying equity.

Notice the careful language. I said in the “long term”, and “at an average rate”. That’s because, in the stockmarket, nothing goes up smoothly. We use phrases like “long-term” and “on average” because we know markets should reflect the value of an underlying business in the long run, but in the short term anything can happen and usually does.

And that’s because, inevitably, there are setbacks. Sometimes, these setbacks have nothing to do with the company. For example, if US inflation surges or China annexes Taiwan, investors will dash for cash and sell shares merely because they fear their shares might decline, even temporarily. Their fear-inspired actions turn that fear into a reality and the shares fall. At other times, share prices react due to idiosyncratic reasons, such as a company reducing its growth expectations.

As I mentioned a moment ago, in the long term it should all work out well, but in the short term, volatility is even more certain.

What if there were a way to grow your wealth at rates similar to those of the broad stock market without the associated volatility? What if there was the possibility of growth and income without the ever-present worry of a stock market collapse that wipes out this year’s and maybe even next year’s St Henri purchase?

Well, now there is and the growing allocation by advisers and individual investors to these private credit funds, such as those we have partnered with at Montgomery, reflects the realisation by a growing band of investors that lending to businesses can be as lucrative as providing the equity without the wild gyrations.

Who wouldn’t want the 9.64 per cent annual returns, generating monthly cash income with no negative months, that investors in one of those funds have enjoyed over the past seven years? While historical returns are not a reliable guide to future returns, and risks do exist, what we do know is that in equities, one thing IS guaranteed: volatility.

Roger Montgomery is the founder and chair of Montgomery Investment Management