In October, stock markets rebounded substantially from losses experienced in the proceeding months. Bond markets experienced some weakness.

October 21, 2015 was immortalised in the 1980’s movie ‘Back to the Future Part 2’ as the date the two principal characters time travel to in a silver DeLorean sports car. The tranquil market environment that persisted for most of 2015 came to an end over the last couple of months with a marked pick up in volatility attributed to a variety of factors, from Chinese growth to U.S. interest rate policy. So far there have been 61 days with a move in the S&P 500 in excess of 1%, ahead of the long term average of 54. While the end of the year typically sees volatility abate, the potential for a Fed tightening cycle to commence in December has the potential to negate this trend. What lessons can we take from the past to interpret future volatile investment environments?

In a 1981 paper the renowned economist Robert Shiller noted that movements in stock prices were excessive relative to subsequent changes in the dividend stream those prices represent. Shiller has returned to this topic several times, considering the role of investor psychology versus rational reactions to changes in fundamentals as a catalyst for episodes of market volatility. In the aftermath of the global market crash in October 1987, he surveyed individual and institutional investors over their behaviour during that period. While the passage of time has developed a narrative for the factors causing the crash, the responses paint a different picture. The survey did not come up with any particular news event that was a catalyst for the sell-off, although there were concerns expressed about valuation and interest rates. Rather, there was a strong belief that investor psychology rather than any change in fundamentals what the main factor at play, with a “contagion of fear” experienced by 40% of institutional investors. Interestingly many were influenced by a historical analog with the events on October 1929.

While 1987 was a long time ago, it’s not hard to believe that advances in communication have only facilitated the transmission of changes in market psychology since then. Human nature being what it is, such changes will invariably occur, leading to volatility episodes. It’s probably a good idea to treat any fundamental explanations with a degree of skepticism. In his 1996 Chairman’s Letter Warren Buffett said he “would much rather earn a lumpy 15% over time that a smooth 12%”. At Toron AMI our principal focus is to look at the underlying fundamentals of the companies we invest in to avoid investments likely to experience undue volatility in the underlying businesses, and we view periods of volatility unrelated to changes in the broad environment as opportunities rather than threats.