This article was originally published in Advisorpedia. May 2022
Like a cat, the stock market can often be inscrutable. You think you have it figured out, then it does something contrary to what you expected. As a financial advisor, you have seen this before. For many clients, they are totally confused. When this happens, they often choose to sit on the sidelines and do nothing. You might feel taking certain actions would be in their best interests. Sometimes an analogy might help.
1. The stock market is like two superheroes locked in combat. You have seen statues of the bull and bear fighting it out. The forces trying to drive the market down are pitted against the forces trying to get it to rise. You choose which superhero you feel will prevail. You would like to get on their side and help them.
2. The stock market and a bad cold. Remember the last time you had a bad cold? You ached all over. You were stuck in bed. You were tired. You were convinced you will never get better. After a few days, the illness past and you recovered. Sometimes the recovery took longer than other times. Although no one can accurately predict the future, there are times when you think the stock market will never recover. Often it does.
3. Each trade has a seller and a buyer. When the market drops, it is tempting to think lots of people are dumping stocks. That is only half the story. The people thinking this is the time to sell a certain stock are matched up with someone else who thinks this is a fair price to be buying that same stock.
4. The stock market is like an unruly child in a store. You have seen this before. Children get tired easily. Sometimes they need changing. Other times they just think screaming is a good idea. They become the center of attention. Eventually the child quiets down on their own or by the intervention of their parents.
5. The stock market is like a rubber band. You can stretch a rubber band quite a bit, but it returns to its original shape when you let go. It can stretch in either direction. If the stock market has a historical rate of return of about 10% on average over decades, if the market suddenly decided to return 20% annually for a few years, it would need some down years to bring the average back to 10% over time. The technical term might be reverting to the mean.
6. The stock market goes up like an escalator and down like an elevator. The point is the rises are often over a longer period and more gradual where the drops can cover a great distance very quickly. The analogy doesn’t imply the elevator heads back up again, but it makes the point because declines are often faster than rises.
7. The stock market climbs a wall of worry. The opposite sentiment is when it looks like everything is aligned and nothing can possibly go wrong, that is when things seem to fall apart. The expression “Buy on anticipation, sell on realization” makes the case. The actual expression is “Buy the rumor, sell the news.” It seems the market can do well despite uncertainty.
8. The majority can’t be right. This is at the heart of contrarian investing. If most analysts and strategists agree the market should head on one direction, that is a pretty good sign it will do something else. This ties in with the cay analogy that started the article. This ties into the concept of investor sentiment.
These simple examples should hopefully result in an “aha” moment from your client, putting them in a favorable frame of mind to follow your advice.
Disclosure: This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax or investment advice or an investment recommendation, or as a substitute for legal or tax counsel. Any investment products or services named herein are for illustrative purposes only, and should not be considered an offer to buy or sell, or an investment recommendation for, any specific security, strategy or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance.
The S&P 500, or the Standard & Poor's 500, is a stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. The S&P 500 Index components and their weightings are determined by S&P Dow Jones Indices. It differs from other U.S. stock market indices, such as the Dow Jones Industrial Average or the Nasdaq Composite index, because of its diverse constituency and weighting methodology. It is one of the most commonly followed equity indices, and many consider it one of the best representations of the U.S. stock market, and a bellwether for the U.S. economy. You cannot invest directly in an index. Past performance may not be indicative of future results. Therefore, no current prospective client should assume that the specific performance of any investment or investment strategy (including the investment or investment strategy recommended by the advisor), will be profitable or equal to past performance levels.
A bull market indicates a sustained increase in price, whereas a bear market denotes sustained periods of downward trending stocks - typically 20% or more. The term "bull vs bear" denotes the ensuing trends in stock markets - whether they are appreciating or depreciating in value - and what is the investors' outlook about the market in general. Bull markets generally coincide with periods of robust economic growth; investor confidence is on the rise, employment levels are generally high, and the economic production is strong. During the bearish phase, companies begin laying off workers, leading to a rise in unemployment and, consequently, an economic downturn.
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