Don Sull's blog

Everyone agrees that the global economy is flying through a patch of extreme turbulence. Recall that Lehman Brothers, which was founded in 1850, successfully weathered the American Civil War, multiple recessions, four financial panics, two world wars, depressions, oil crises, and 9/11. But the storied firm could not survive the seizure of global capital markets in 2008.

The present economic crisis has been so dramatic, that many people think it caused the volatility roiling markets. If the crisis triggered turbulence, according to this line of thinking, then the global economy should return to a period of stability once the worst of the downturn is behind us. Not so fast. Turbulence did not begin on September 9th, 2008. And it will not end when the global economy pulls out of recession. The current economic crisis is not the cause of market turbulence, it is simply the latest symptom of the volatility inherent in global markets.

Consider how much has changed in the decade or so before Lehman’s collapse. When PricewaterhouseCoopers began their annual chief executive survey in 1996, less than one-third of CEOs regularly logged onto the Internet, and few saw China, Russia or India as priority markets. The intervening decade saw the dot.com boom and bust, major currencies crises in Asia and Russia, 9/11, two wars in the Middle East, unexpected jumps in commodity prices, and the rapid rise of emerging markets. And all of this before Lehman imploded. A variety of studies, by scholars from different fields using diverse data sources and methods has converged on a remarkably robust conclusion. Individual firms face volatility that has risen between two- and four-fold in recent decades.

A comprehensive study of equities traded on all major stock US markets found that the volatility in returns of individual stocks more than doubled between the early 1960s and the late 1990s, spiking when the economy entered recession and when stock markets crashed. Research by Harvard’s Diego Comin and his co-authors document that the volatility of revenues, profitability, and employment of publicly-traded firms in the United States have more than doubled between 1960 and 2000. (Greater volatility at the firm level has not increased aggregate volatility in stock markets as a whole, because the more violent upward and downward movements of individual shares canceled one another out).

Other measures of turbulence show an even larger increase in recent decades. The probability that a public firm disappears in any ten-year period more than doubled from the 1960s to the 1990s. The odds that that a high-performing firm would be dethroned from industry leadership tripled between the 1970s and the 1990s. Another study by Comin found the spread between corporate bonds and ten-year treasury bills, another measure of firm-level risk, increased four-fold over the same period. The global economy experienced nearly 250 currency crises between 1978 and 2003.

A World Bank analysis found the speed with which technological breakthroughs spread globally increased four-fold between the first half of the Twentieth Century and the period after 1975. According to a recent study by the IMF, there were four global economic crises between 1870 and 1980. By their reckoning there have been the same number between 1980 and the present. The increase in turbulence is neither uniform across industries or countries nor steady over time. The broad trend of turbulence rising is unmistakable.

The downturn will end, but turbulence is here to stay. This has important implications for managers which I discuss in my book The Upside of Turbulence, Over the next few months, my posts on this blog will discuss how managers can seize the opportunities and mitigate the threats that arise out of volatile markets. Stay tuned.