Clients’ gloom over the market’s continuing decline amid dour economic outlooks might be likened to the dread experienced by the prisoner in Edgar Allan Poe’s classic 1842 short story “The Pit and the Pendulum.”
Instead of a suspended razor-sharp blade descending slowly toward their midsections, the horror faced by Poe’s prisoner, advisors’ clients fear their holdings will be eviscerated. Instead of the Spanish Inquisition, the torturer is the sustained high inflation strengthening the Fed’s resolve to continue raising the federal funds rate.
In the end, the hero of the short story escapes both the blade and jeopardy from falling into a seemingly bottomless pit—but not without experiencing many hours of unspeakable horror.
As a metaphor for clients’ current dread, even this tale is too cheery for Harry Dent and Jeremy Grantham, who predicted (yet again) a sudden, extremely deep stock market crash for 2022—one that might mean an unthinkably long, hard slog for recovery. Yet, although air has been escaping from market indexes all year, lowering valuations—and thus the likelihood of a catastrophic decline—neither prognosticator has revised his prediction (the norm for those who habitually warn of apocalypse). Though clients may currently be experiencing Poe-esque dread, their likely fate, according to Dent and Grantham, would be much worse than that of Poe’s protagonist, who escaped physically unharmed.
Such doomsaying, along with headlines about long-term market weakness and recession (“imminent” for several months now), has become etched on client psyches, making them candidates for the Institute for the Very, Very Nervous in Mel Brooks’ movie, “High Anxiety.”
How can advisors address this kind of gloom? As always, the best way is to use a substantive approach. Historical perspective, coupled with insights into market dynamics, is usually more persuasive than the standard preachments on the virtues of staying invested to reap long-term average market gains. Cold, hard facts from economic and market history can calm jittery nerves, assuming that these facts legitimately support a plausible, positive view.
Unbeknownst to many investors, they currently do. Here are a few client talking points:
• The upcoming election will probably help. The typical result of midterm elections is to produce divided government, with the party not in the White House usually winning the House of Representatives (which the GOP is heavily favored to do in November). The market likes split government because it usually assures that little will get done, an outcome that’s all the more likely in this era of hyper-partisanship. Fewer changes mean less market uncertainty, and uncertainty tends to discourage investment. If the market follows the classic midterm election-year pattern, values will rise in November and December, and will continue to do so throughout the year. In the 12 months following midterm elections, the S&P 500 has been positive every time since 1946, with an average gain of 15.1%, compared with 7.1% in non-midterm years.
• The contrarian indicator of individual investor sentiment is currently sanguine, ironically because these individuals aren’t. Periods of especially bearish individual investor sentiment are usually a good time to invest because individuals almost always get it wrong; the market has almost always done well at these points. Recent surveys of its members by the American Association of Individual Investors show a ratio of bulls to bears of -43.2%—the lowest since 2009, after the onset of the Great Recession.
• Bears only roam so long without going back into long hibernation. The average bear market has lasted 289 days, according to Ned Davis Research. As the current bear market officially started the first week in January, the average duration would have it ending the third week of this month, give or take—in this case longer, as we’re still in a Fed rate-hiking cycle. But we might get more clarity on this cycle’s duration in the coming weeks.
• Strong market gains after rate-hiking cycles end are common, and they can be substantial. In six-month periods after these cycles since 1994, the S&P 500 has on average returned about 19% and real estate investment trusts (REITs), nearly 35%.