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Advisors: Can You Explain Market Volatility in Simple Terms?

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The recent market declines don’t seem to make sense.  Clients are confused.  Often the explanations from analysts are complex and difficult to understand.  Your client has faith in you, but they want concepts they can easily grasp.  What can you do?

The word “parables” appears frequently in the Bible.  Simply put, they were a form of story that explained a complex concept using everyday analogies people can understand.

A Baker’s Dozen of Analogies and Explanations

The following 13 examples aren’t meant to provide technical answers.  They are meant to align stock market behavior with something the client can easily understand.

Having a Cold.  When you have cold, the symptoms worsen.  You take medications.  They don’t work.  The cold moves to different parts of your body.  You decide this isn’t going away anytime soon.  One day you wake up healthy.  The cold has gone.  It needed to run its course.  The stock market catches colds too.  It needs time to work the cold out of its system.

Super Heros or Sumo Wrestlers.  You’ve seen the action movies where two evenly matched super heros slug it out.  Each one appears unstoppable.  The tide of victory moves back and forth.  The market with its struggles between bulls and bears is similar.

The Weather.  When a storm is coming, it becomes the major TV news story.  Statistics get pulled out.  The commentators focus on the worst happening somewhere.  Power outages.  Highway accidents.  It seems like the carnage will never end.  Suddenly it does.  The storm is forgotten as they move onto the next story.  Unfortunately, people have short memories.  They forget the damage and the outcome, treating each storm as if it’s the first one they’ve ever seen.  The stock market goes through its share of storms too.

Elevator/Escalator.  It’s often said the market rises like an escalator and falls like an elevator.  The escalator moves gradually in one direction.  It takes time, but it makes progress.  The elevator drops quickly.  Market climbs are often slow, but steady.  Declines are often sudden, but fast.

Binge/Purge Syndrome.  You’ve heard about people who overeat, then take extraordinary steps to keep their weight down.  The stock market is made of buyers and sellers.  If it’s gone up for quite a while, some investors may say “It’s time to reallocate assets, I’m overweighed in equities.”  When the market declines, some investors say, “These stocks are cheap at the price.”

Rubber Band.  You’ve stretched a rubber band before.  It might get extended, but when you release it, the rubber band returns to its original shape.  It isn’t broken.  It’s ready to be extended again.  The stock market can get overextended.  It pulls back to correct itself.

99 People Can Be Wrong.  The stock market rarely does what the majority of people expect.  The concept of contrarian investing is based on going against the crowd.  A rational person assumes if most analysts agree on the market’s future direction, that’s a sure thing.  When talking about the stock market, when everyone agrees on something, that’s a bad sign. 

History Repeats Itself.  We all remember: “Past performance is no guarantee of future results.”  We forget there are few if any guarantees in life.  The markets tend to move in cycles, although the length can vary.  If we are in a period of slowly rising interest rates, this has happened before.  When studying the stock market, it’s worthwhile looking to history for similar circumstances and learning who benefitted.

Acceleration.  You finish a week when the market was down every day.  That’s grim.  If, each day, the market was down more than the previous day, the decline is accelerating.  If the decline each day is less than the decline the previous day, the decline is slowing.  That’s a reason for optimism.  The stock market doesn’t need a reversal before you can be optimistic.  Deceleration implies more people are buying or less people are selling.

Bridge and Tunnel Traffic.  An advisor in New York tells this story:  It addresses a different issue:  growth vs. value.  Which is in favor?  If you’ve commuted in heavy traffic, you’ve had times when the other lane is moving faster.  Fed up, you switch lanes.  Now the other lane is moving faster.  When you eventually leave the tunnel, you often see the car that was alongside you at the start is in the same position.  With the stock market, both growth and value investing each have their day in the sun.

Three Data Points.  Anxiety sells.  TV news commentators talk about the market having several bad days in a row.  They quote “worst day/week/month” statistics.  They have two data points:  Where prices were and where they are now.  They don’t have the third point:  Where prices will be in a day/week/month.  No one can predict the future.  They can guess, but they cannot predict.

Anticipation/Realization.  Why does the market go down when the economy is doing well?  The stock market is considered to be a leading indicator for the economy, looking six or more months into the future.  An old rule of investing was “Buy on anticipation, sell or realization.”  As an example, the US put a man on the moon in 1969.  This implies the time to sell aerospace stocks was when Neil Armstrong said: “The Eagle has landed.”  Some investors feel the time to sell is when, at last, everything is going right.

Turns on a dime.  When the market declines, bad news seems to keep coming.  When you convince yourself things will never get better, and I better get used to the “new normal” it can turn around.  Why?  Because every trade has a buyer and a seller.  Prices decline to a point where a large enough group of people think stocks are cheap at the price.  The stock market can turn when it appears the majority of people are convinced it won’t.  You’ve heard the old saying: “Nobody rings a bell at the top or the bottom.”

Related: As an Advisor, Are You “The Great Communicator?”

When the market declines, your client wants answers.  Your carefully researched explanations may be difficult to put into simple words.  Sometimes, you need an easy to understand concept people can easily grasp.  That gives you a base to build on as you continue the explanation.

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