Why you should worry about wobbles

A volatile market is not a happy market

By James Arnold BBC News Online business staff

It may be anyone's guess where stock markets will be in a month's, or even a week's time.

But one thing's for sure: they will flap about terrifyingly on the way.

One of the markets' most stomach-churning weeks has just come to a close, with the Dow Jones lurching down 400 points and gunning back up 700, before ending up not a million miles from where it started.

Over the past few days, and more generally since 11 September, this sort of volatility has penetrated to even the most sedate corners of the stock markets.

Wherever share prices do end up, the effects could be deeply unhealthy.

The bigger they are...

This latest bout of volatility is no respecter of reputations.

Not all investors want to take risks

Until not so long ago, the buccaneering hi-tech shares of New York's Nasdaq and its equivalents were where fortunes were won and lost; blue chips, by contrast, offered staid but steady returns.

Now, the real gyrations are being felt on the Dow, the index that gathers America's - and therefore by extension the world's - 30 most respectable shares.

On Wednesday, the Dow surged by 500 points, its second-biggest one-day gain in history.

The day after, it gained just five points - but on the way fell by about 200 and leapt by 150 twice over.

... the more they flap

The same skittishness is visible at individual company level.

It is now far from uncommon for major blue-chip shares to gain or lose 20% or more in a day - something almost unheard-of over the past few years.

And these swings are not the product of thin markets and bored traders.

On the New York Stock Exchange on Friday - a rather boring day by recent standards - half the top 10 shares by turnover had moved by more than 10%.

Blues become reds

There is, of course, a good reason for this.

Investors were already nervous, coming into 2002 on a wave of economic pessimism and with 11 September fresh in their memories.

Volatility is bad news for the little guy

But there was nothing to suggest a situation significantly more alarming than in previous periods of market turmoil - around the Russian devaluation of August 1998, for example, or amid the Asian economic gloom of October 1997.

The wave of accounting scandals to emerge since the collapse of Enron last December has, however, changed all that.

As superstar chief executives swap their pinstriped suits for ones with little arrows all over them, the solidity of blue-chip status has been conclusively undermined.

Over the past few months, a series of top-drawer names - Xerox, AOL Time Warner, Citigroup, WorldCom - have either been humbled or destroyed, and investors are casting around for the next victim.

The price of wobbling

Hence the volatility.

But surely volatility itself is not to be feared? Surely minute-by-minute lurches in shares count for nothing, if the long-run returns on shares remain positive?

Only up to a point.

The first main reason to fear volatility is the way it redistributes wealth in the market.

At times like these, market veterans, especially insiders in the big brokerage firms, can prosper; indeed, the thing these people really fear is stagnation.

The ordinary investor, by contrast, almost invariably gets burnt.

Average punters, who tend to buy stock rarely and hold it for a long time, much prefer sustained periods of rising markets, such as the long bull market of the mid-1990s.

As such, a volatile market represents a huge transfer of money from the small fry to the sharks.

Corporate woes

Second, volatility makes life miserable for companies, which need a predictable share price to use as an acquisition currency or means of raising finance.

It's not just the long term that troubles investors

Companies whose shares are twitching to and fro find it harder to borrow money, and indeed are statistically more likely to default.

Many big mergers are paid for with shares, and big changes in those can derail deals before they complete.

Since 11 September, a string of major mergers have come off the rails, more because of uncertainty than prevailing market gloom.

Only the sad see-saw

Third, and most straightforward, a volatile market is rarely a happy one.

If you think this is exciting, try General Electric

Bull markets tend to move smoothly upwards; big short-term movements, even upward ones, are far more characteristic of negative sentiment.

Bear markets have more to do with uncertainty than with decisive gloom, and yo-yoing shares are the clearest possible evidence of that.

If market volatility only serves to compound the current gloom, small investors will doubly suffer.