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%.

• Even if the economy were truly in bad shape currently, this wouldn’t necessarily pummel market growth, especially after this year’s decline. The economy isn’t the same entity as the stock market, and vice versa. The two are like estranged cousins who may see each other sometimes at Thanksgiving but otherwise rarely speak because they have a fundamental difference: Economic data is necessarily backward-looking, and the market, always forward-looking. So conflating one with the other can easily misplace forecasts of economic downturn on market projections. Remember that one of the greatest U.S. bull markets of all time started galloping through the Great Recession, after a deep decline. Another bull market started in 1982, when inflation was elevated.

• Fretting over anticipated earnings declines is much overdone. Naturally, earnings of many companies were messed up by the pandemic and its aftermath. Average forward 2-month EPS for the S&P 500 stood at about $240 early this month. Yet, as of the week of Oct. 17, Q3 earnings reports had started coming in better than expected. And even if the average figure turns out to be as low as, say, $210, this would still be more or less in line with the index’s long-term upward earnings trajectory. And with a lower numerator, P/Es will of course be fine.

• Inflation may start to come down sooner than many dire projections indicate. The University of Michigan survey of five-year inflation expectations, one of the best predictors, shows that many investors believe inflation is already starting to roll over, en route to 2% to 3% within the next few years. This indicates a belief that the Fed may come close to its 2% target, after all. Considering the accuracy record of this survey, there’s a real possibility that their intuition may be better than that of many economists and Wall Street figures predicting all but certain failure by the Fed, sustained ultra-long-term inflation and a nasty recession next year to boot.   

Thus enlightened, many clients may feel liberated from the emotional ropes holding them victim to the deadly blade swinging over their holdings. Then they might be inclined to discuss allocation changes for the coming, post-pendulum market.

Dave Sheaff Gilreath is a founding principal and CIO of Innovative Portfolios, an institutional money management firm, and of Sheaff Brock Investment Advisors, for individual investors. Based in Indianapolis, the firms manage assets totaling about $1.3 billion.