The last several years have been remarkable for the gains across the major asset classes. A commensurate, albeit lesser-known trend is the fall in volatility generally.
Consider our chart below, which graphs rolling 36-month, annualized standard deviation of monthly equity total returns through December 31, 2006. It’s clear that stock markets overall have become calmer, gentler beasts. The trend has been particularly notable in emerging markets, as per the MSCI Emerging Markets Index. At the end of last year, the benchmark’s volatility weighed in at an annualized 17.6 standard deviation for the past three years, down from more than 30 in 2001.

A shift in volatility trends may or may not aid investors. Much depends on the context. As valuations high or low? Is the economy in recession or growing? Does a bull or bear market prevail? No too periods are alike, which is what makes investment analysis so much fun, and often times so frustrating for those who like reliable predictions and tidy profits.
History viewed through the prism of volatility is instructive, but not always prescient about the morrow. Indeed, the rising volatilities of the late 1990s accompanied a surge in prices. In contrast, the last few years have witnessed falling volatilities and strong bull markets.
It’s tempting to draw the lesson that bull markets can persist in both periods of falling and rising volatility. But the future may not be so kind to such thinking. Higher volatility is probably coming, one day, and history reminds that sometimes higher volatility is forged by falling prices.
For those wearing rose-tinted glasses and expecting only sunny skies, a change in the volatility climate could be shocking. For those prepared, by contrast, a jump in volatility offers a fresh chance to exploit the portfolio-wide blessings that flow from rebalancing. Higher volatility may be coming, but the trend could be just the thing that strategic-minded investors have been waiting for.