Factors affecting volatility

Since 2020, markets have experienced a number of events that have increased volatility and stress for investors. The COVID-19 pandemic has brought enormous uncertainty that has significantly impacted global markets. Long-term concerns about macroeconomic developments, rising inflation, and the 2022 equity slump caused by rising interest rates and the energy crisis have further increased volatility. Recent concerns include a possible halt in the current growth of technology stocks, which is linked to the development of artificial intelligence, and an expected reduction in interest rates.*

How do we measure volatility?

To properly understand current events in the technology sector, we must first understand volatility, which can be idicated through various methods of technical analysis. To better illustrate, we will use the shares of Nvidia and Meta Platforms as an example.

Standard deviation

The primary indicator is the Standard Deviation, which expresses the average deviation of the share price from the mean value over a certain period. The higher the value, the greater the volatility in the market. This is a statistical tool that is also widely used in financial analysis, but is not commonly used in practice, although there are exceptions such as the technical indicator Bollinger bands.

Beta

A more practical and important volatility indicator is Beta, which measures the movements of a stock price relative to the broader market, the so-called benchmark, usually the S&P 500 index. A Beta of 1 means that the stock has volatility similar to that of the overall market. If the value of the S&P 500 falls, a stock with a beta of 1 is likely to experience a similar decline.

More stable stocks, such as utility stocks (water utilities, electric utilities), have a beta of less than 1, signaling lower volatility relative to the market. During August 21, 2024, this value stood at 0.1. Conversely, stocks in emerging industries, particularly in the technology sector, often have a beta greater than 1, indicating higher volatility and thus will rise more and fall less than the index. To better illustrate - during the same trading day in the second half of August, the beta of the technology sector was currently 1.9. Specifically, Nvidia shares had a Beta of 1.68 and Meta Platforms shares had a Beta of 1.21. A Beta of 0 indicates that the underlying security has no market volatility.* In this case, cash is a good example, unless we consider inflation.

Chart: the evolution of Nvidia's Beta (Source: https://www.zacks.com/stock/chart/NVDA/fundamental/beta )*

Chart: the evolution of Meta Platforms' Beta (Source: https://www.zacks.com/stock/chart/META/fundamental/beta)*

Volatility Index VIX

Another important volatility indicator is the VIX index, also known as the "fear index". The VIX is an indicator of expected volatility in the stock market, based on S&P 500 index options, and is calculated and shared in real time by the CBOE. Values above 20 generally indicate increased volatility over the next 30 days, while values between 13 and 19 are considered an indicator of lower volatility. Its value reached 15 on August 21, indicating that the market was expecting lower volatility.

Chart: development of the VIX Index (Source: Yahoo Finance)*

Relationship between risk, return and volatility

There is a positive correlation between risk and return (a relationship where both variables move in the same direction) with one important caveat: there is no guarantee that taking more risk will lead to higher returns. On the contrary, higher risk may lead to greater losses. Lower-risk investments generally have lower profit potential, while higher-risk investments have higher profit potential but also higher loss potential.

Volatility is also positively correlated with risk and return. Higher risk is often associated with higher volatility investments. Therefore, technology stocks are much more volatile compared to defensive utility stocks. Higher volatility means that more volatile stocks can deliver potentially larger losses, but also potentially larger gains.

Volatility in the technology sector remains elevated

It is not easy to determine which of these factors has contributed most to increased volatility. However, we can see from analysis of the VIX index that market volatility has returned to pre-pandemic levels following the decline in inflation. However, volatility in the technology sector remains elevated and, for example, the Technology Select Sector SPDR Fund, an ETF that tracks the technology sector, has shown a long-term uptrend. This growth is the result of strong corporate earnings, which have translated into strong share price growth in the sector.*

Chart: share price development and Betas of the technology sector SPDR (Source: Yahoo Finance)*

Chart: share price development and Betas of the SPDR utility sector (Source: Yahoo Finance)*

Profits outperform other sectors

While we have seen a number of events since 2020 that have increased volatility in the technology sector, the current surge is mainly driven by the high profitability of technology companies, which has significantly outperformed other sectors of the S&P 500 over the long term. If their profitability were to decline, we could expect their stock volatility to decline as well, although it would likely remain above the average for the market as a whole. [1]

Olivia Lacenova, principal analyst at Wonderinterest Trading Ltd.

* Past performance is no guarantee of future results

[1] Forward-looking statements are based on assumptions and current expectations, which may be inaccurate, or on the current economic environment, which may change. Such statements are not guarantees of future performance.They involve risks and other uncertainties that are difficult to predict. Results may differ materially from those expressed or implied by any forward-looking statements.