Volatility is the New Normal

Helping employees ride through the volatility of the market may be critical now. Plan Sponsors can do that by helping employees understand volatility itself.

While employees adjust to the new normal of social distancing, they may also be trying to adjust to the new normal of stock market volatility. Understanding how habituation works may help those employees to be savvy investors in the long run.

Normal has a very different look in the Spring of 2020. Physically, many Americans are practicing social distancing, something the National Parks Service referred to as applying the rules to interacting with wildlife to humans. Normal may also look different financially to many people for a long time too.

That could be because the volatility of the stock market has come to be almost expected. While the initial shock of the sharp selloff on Monday that triggered market cooling techniques caused concern, by Friday volatility was somewhat less of a shock. That diminution in shock could have occurred for a variety of reasons, but one of them has to do with habituation.

Habituation is “the diminishing of a physiological or emotional response to a frequently repeated stimulus.” In other words, the more you are exposed to a thing, the less you react to it. A few common examples of habituation include repeated exposures to a sound. For example, a wailing siren in the middle of the day to a college student in semi-rural Ohio means a tornado is imminent and to seek cover. The reaction to this not frequent event is a fast dive towards the basement of a dorm. Move that college student to suburban Philadelphia, where sirens wail frequently, and mean a volunteer firefighter needs to report to the firehouse, and she’s much less likely to even raise an eyebrow, let alone move away from the sound.

Habituation also impacts positive stimuli. Studies show that college students will prize pizza as a reward or treat when it is an infrequent dinner item. But when exposed to pizza every night for 30 days, they value pizza much less highly. The key characteristics to habituation are duration, frequency, intensity and consistency. Duration here refers to how often something occurs. A noisy dog barking every night at 9 p.m. becomes easy to get habituated to by the 4th night. But if it came and went – say Fluffy barked every night for four days and then stopped for two weeks before returning to yowling the song of his people– it is harder to develop that lack of response because the duration of the event was short. Frequency, on the other hand, refers to how often something occurs, here Fluffy barking every night would have a high frequency. You can become habituated to something that doesn’t happen frequently, but has occurred for a length of time. This can happen with employees who have a boss that yells at meetings. It might not happen every meeting, but over ten years of working with that boss, some employees will be habituated to the toxic behavior. Intensity refers to how strong the stimuli is. People will almost never become habituated to a smoke alarm because of how intense the sound is. Consistency refers to whether the event changes over time. If Fluffy’s barking yowling grew louder or more higher in pitch, it would become noticeable again.  

Stock market changes can be something that employees can become habituated to over time. Rapid fluctuations in the market may habituate employees to not necessarily the high highs or the low lows of the market, but to the volatility itself. What exactly is volatility? Investopedia defines it as “a statistical measure of the dispersion of returns for a given security or market index.” As it applies to the stock market, volatility “is often associated with big swings in either direction” usually more than 1% over time. Back in 2018, analysts said that the stock market had reintroduced volatility. “Between Aug. 17 and Oct. 9, the average daily range — the difference between the intraday high and the intraday low — was 177 points. Between Oct. 10 and Nov. 16, the average daily range was 455 points, 2.5 times greater.” As to the corona virus’s effect on the stock market fell about 9 to 10% (depending on the index) on March 12, 2020. On March 16, 2020, the stocks fell about 12 percent. As the New York Times reported: “’Unfortunately, this is the new reality. This report is a harbinger of what is to come,’ wrote economic analysts with investment bank Jefferies in New York.”

Here, stock market volatility could hit those 4 criteria for habituation. It is something that has been occurring since 2018, and in the Spring of 2020 has persisted for more than a week and might continue to persist. As of March of 2020, the volatility in the stock market has become quite frequent. However, a major crash that triggers market timeouts is arguably intense. The fact that more than twice in 10 days the drop has been noted as “historically big” is arguably too intense to become habituated to. However, the drops in the market may not be something an employee or investor could become habituated to, but the drop and rise phenomenon might be. The drop and rise and drop again has the consistency that could argue for habituation in that it is showing a level of consistency in volatility.

It’s possible that the new normal for regular investors in the market may be volatility. And if that was true, then those regular investors may be less likely to have an emotional reaction to that volatility. Helping employees ride through the volatility of the market may be critical now. Plan Sponsors can do that by helping employees understand volatility itself.

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