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Complacency will get you into trouble, at least in the financial markets. Back in February, when the U.S. stock market dropped almost 3.5% in one day (following an 8% plunge in the Chinese market), investors became alarmed, newspapers ran front-page headlines for several days, and television “experts” opined about the market’s sudden volatility.
It wasn’t the market that had suddenly become volatile. It was the shock to the perceptions of complacent investors that made them think that the February decline was unusual. That is far from the case: one-day market losses of 3% or more occur on average 1.5 times a year. Some years experience more and larger declines, some less, but such moves are the norm. Many investors, however, seem to think that markets are a lot less volatile than they really are.
It wasn’t the February decline that was unusual: rather, it was the 989 trading day stretch—nearly four years—since the last one-day decline of more than 3%. That long period was unusual, yet there were no front-page headlines alerting investors to this.
Investors also had a tendency to read too much into February’s decline. Did it tell us anything about the future course of the global stock markets? Not really; such declines occur in bear and bull markets and they have little predictive value. It would not be unusual, even in an ongoing bull market, to see more declines like this in the coming months, even back to back declines. Even this would not provide worthwhile information to help us predict the market’s direction.
Investors must learn that volatility in the markets is a lot more common than they think. That’s why it is common to see sharp upswings during bear markets and equally sharp downswings in bull markets.