When a plane encounters mild turbulence, no experienced person gets up from their seat thinking the plane is going to crash. The belt tightens, the glass of water shakes, but the pilot doesn’t even change course. However, in the financial market, many investors panic in the face of shocks much smaller than those which characterize a normal flight.
Epictetus, a Stoic philosopher from the 1st century, wrote that it is not events that disturb men, but the judgment they make about them. In the stock market, this phrase takes on an uncomfortable relevance.
I am often asked the question: “Michael, with this stock market stress, is it time to leave?” Most of the time, the source of doubt is a weekly fluctuation between 1% and 3% or a monthly drop close to 5%.
For those accustomed to the almost linear curve of the CDI, it feels like an earthquake. Post-fixed income securities have accustomed Brazilian investors to not looking at prices. When he starts looking, any fluctuation seems too great.
The stock market is, by definition, a volatile asset. Unlike fixed-income securities, which virtually do not fluctuate in value from day to day, stocks carry uncertainty, expectations, and constant revisions of expectations regarding the variables that affect company profits. Oscillation is not a fault of the stock market, but its nature.
To separate noise from real stress, it helps to look at the statistics. Calculating the standard deviation of Brazilian market returns over the past 20 years, we found something very telling. The typical weekly fluctuation was around 3.3%, while the monthly fluctuation was around 6.4%, without any annualization.
This means that movements of this order are not the exception but the rule. If we consider something between 1 and 1.5 standard deviations as natural, we are talking about weekly variations which can approach 5% and monthly movements which easily reach almost 9% without anything extraordinary happening.
This trend is not exclusive to the Brazilian market. On the world’s leading stock exchange, the S&P 500, the historical standard deviation of weekly returns is around 2.4%, while monthly returns are close to 4.2%. Applying the same reasoning we used above, weekly fluctuations of around 3% and monthly declines of almost 6% are also part of the normal dynamics of the American market, without this characterizing, in itself, any crisis scenario.
Oscillations within this range represent the vast majority of cases. These are common, frequent and statistically expected movements. They do not, in isolation, convey a deeper message about the collapse, rupture or structural change of the scenario.
But then, when should investors really worry?
The market begins to enter a more obvious level of stress when variations exceed this level. Movements larger than 1.5 or 2 standard deviations are no longer common and are beginning to reflect relevant events, such as macroeconomic shocks, political crises, financial disruptions, or abrupt changes in risk perception.
Confusing a normal price realization with an extreme event is a recurring error. And this mistake is usually costly, because it can lead the investor to make bad decisions, precisely when the market is simply doing what it has always done.
Understanding the natural fluctuations of the stock market doesn’t eliminate the discomfort of watching prices fall, but it does help put each move in its proper place. As with airplane turbulence, the problem is rarely simple swaying. In the stock market, the problem is also the judgment we make of it.
Michael Viriato is an investment advisor and founding partner of Investor House.
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