Market Mysteries: Part One
Updated: Mar 15
With all the volatility we’ve been seeing in the financial markets lately (mostly on the downside, unfortunately), many are reflecting again on the difficulty of truly comprehending the markets. As financial planning professionals, we often hear people confess, sometimes in embarrassment, that they don’t really understand investing or the markets.
Candidly, the investing part is pretty simple: you put together a thrifty portfolio (with low annual internal expenses) with a mix of US and international stocks and bonds, leavened perhaps with real estate or other alternative asset classes. The precise mixture is often less important than a steady hand at the tiller, which means not doing a lot of trading or making a lot of changes. That part is pretty easy to explain and understand.
The markets and how they move, however, offer a completely different problem. In fact, it is fair to say that in that sense, nobody understands the markets: nobody knows precisely why they move (or have moved) up and down in the short term, or when they will, or in which direction—nobody.
Why is that? The problem with predicting market movements in any time frame under 10 years is that there is a heavy dose of sentiment behind the dynamics. You can think of it as mass psychology. Tens of thousands of stock owners wake up in the morning and either feel anxious or confident, which means they are prone to selling or buying. Professional investors, of course, are holding tight, but there are a lot of individual investors, especially now in the age of online trading platforms, who are trying to figure out whether the markets are about to go up or down this week—or even today. Add to that the brokerage traders who stare at six or eight different video screens, trying to determine how those individual investors are feeling this morning, and then adding their buy or sell orders—which amplifies the psychology of the moment.
You can see these things play out in real time. To take an example from all-too-recent history, suppose one morning a slight majority of investors suddenly decide that the viral disease they were hearing about in China has arrived on US shores, is not contained, and might be a bigger threat than they realized. Next, suppose that a worldwide health organization declares that this disease is, in fact, a full-blown, worldwide pandemic. This might force companies to allow their people to work from home, and how efficient can that be?
Best to sell stocks and move to the sidelines, the individual investors decide. Traders notice the trend, amplify it, and the market goes down a percent or two.
The next morning, a slightly bigger majority of investors (maybe 54% as opposed to 52%) notices that the market has gone down and also realizes that the pandemic might be really bad for business. They log into their brokerage accounts with sell orders. Traders notice a pattern and move accordingly. A few more sessions, and suddenly there’s a rush for the exits that has nothing to do with the underlying fundamentals of global businesses.
Then, one day, a slight majority of investors notices that companies are actually coping pretty well with having workers do their jobs at the kitchen table. Who imagined that? They see that stocks are “on sale,” cross their fingers, and start adding to their holdings. Traders notice that the sentiment has shifted, and they start buying again, too. The markets begin to rise, and a lot of individual investors, still on the sidelines, rue the day that they participated in the sell psychology, because now, stocks are higher than when they sold. Belatedly, they get back in, and the market recovery is sustained.
In retrospect, it seems obvious that the downturn was a temporary dent in the long-term uptrend. But these things are never obvious at the time—never.
So, if you feel embarrassed to say that you don’t understand the markets, don’t worry; you have plenty of company. As in: the rest of the world. And in Part Two of this article, we’ll take a look at why, despite the unpredictability of the markets, some investors do better than others.
At Bernhardt Wealth Management, our goal is to provide clients with the guidance, research, and long-term experience they need to allow the markets to work for them, instead of against them. To learn more, click here to read our article, “What the Markets Taught Us in 2020.”