What causes market volatility?

Releases like GDP growth, inflation and employment numbers can cause significant market swings, especially when they deviate from expectations. For example, if monthly inflation data shows prices rising faster than expected, investors may anticipate more aggressive interest rate hikes, which can trigger declines in both stocks and bonds.

These data points are closely linked to where we are in the business cycle — the natural rise and fall of economic activity over time. Markets often react most at turning points, when growth begins to slow or signs of recovery emerge.

It’s important to remember that while economic data can jolt markets in the short term, longer-term trends like innovation and productivity tend to carry more weight over time. During the 2008 financial crisis and again in early 2020, economic data releases became breaking news, with each inflation or jobs report triggering swift reactions. While short-term volatility followed, markets ultimately rebounded and long-term investors saw their portfolios recover and grow. 

One of the most influential forces on markets is monetary policy, especially changes to interest rates. Central banks like the U.S. Federal Reserve and the Bank of Canada adjust rates to keep inflation in check and support economic growth. But these decisions and even hints about future moves can cause market volatility.

In the early 1980s, the Fed raised rates to nearly 20% to control runaway inflation. It caused short-term pain in the form of recessions and market turmoil but ultimately stabilized the economy and laid the groundwork for a long bull market. So while markets can react sharply to policy shifts at first, they tend to recover and even thrive once the economy finds its footing.

Markets dislike uncertainty and geopolitical events are one of the biggest wildcards. Wars, trade disputes, elections and diplomatic rifts can all shake investor confidence, disrupt global supply chains and alter the outlook for economic growth.

While geopolitical shocks can’t be predicted, their long-term impact tends to be absorbed as markets adapt to new realities. During the Gulf War, the S&P 500 fell 18% following Iraq’s invasion of Kuwait on August 2, 1990. But weeks after Operation Desert Storm began in January 1991, markets rebounded. A year after the initial drop, the S&P had not only regained its losses but also delivered significant gains.

Markets are not purely rational. Investor sentiment driven by fear, greed or herd mentality can amplify volatility, even when fundamentals haven’t changed. When fear sets in, sell-offs can become self-reinforcing. When optimism runs high, valuations can overshoot.

We saw this in the dot-com bubble of the early 2000s, when tech stocks surged on hype, then crashed. Again in 2008, panic selling pushed prices far below intrinsic value. And in the 2020 pandemic, fear caused one of the fastest market crashes on record, followed by one of the fastest recoveries. The takeaway here is short-term sentiment is powerful, but it rarely reflects long-term value.

Liquidity refers to how easily assets can be bought or sold without affecting their price. In a well-functioning market, there are usually enough buyers and sellers to keep prices stable. But during times of uncertainty, that balance can break down.

When fewer people are willing to buy, even a small amount of selling can push prices down quickly. When major banks failed in 2008, it triggered a wave of selling driven by fear and urgency. At the same time, stock prices dropped sharply and swung wildly day to day. As central banks stepped in to restore confidence and lending conditions began to stabilize, markets recovered and went on to reach new highs.

Stock prices are closely tied to how much profit companies make, and how much they’re expected to make in the future. That’s why markets react when earnings fall short or companies stop sharing forecasts — also known as withdrawing guidance.

Earnings naturally rise and fall with the business cycle. During periods of uncertainty or economic contraction, companies often scale back expectations. For example, after September 11, many companies withdrew guidance due to global uncertainty. And in 2020, the pandemic led to a widespread suspension of forecasts across sectors. In each case, markets became volatile as investors reacted to limited information and shifting outlooks. As recovery took hold, spending returned, earnings began to rebound and markets followed suit.

Volatility often spikes in response to sudden, unanticipated events, whether geopolitical, environmental or economic. These shocks introduce uncertainty and trigger rapid market reactions. Black Monday in 1987, the September 11 attacks and the onset of COVID-19 all caused sudden, steep declines.

But they also revealed a consistent truth: recovery follows crisis. Sometimes quickly, sometimes slowly — but resilience has been the rule, not the exception. While the short-term path may be jagged, the long-term trend has historically been upward.

Volatility is part of investing, and understanding what causes it helps investors stay grounded when headlines feel overwhelming. We’ve seen these forces before. And we’ve seen what happens next.