Beware of false bottoms

What is a false bottom? And why should you consider talking to your clients about them?

Stock market behavior has always been difficult to predict, and that’s proven to be especially true in 2022. Among other things, stubbornly high inflation, rising interest rates, and the ongoing war in Ukraine have stoked fears of a global recession and led to an increasingly volatile market. The S&P 500 is down considerably¹ since the start of 2022 and with recent interest rate hikes, some analysts are growing concerned about how long this bear market will persist.

Given the down market, some clients may think now may be a good time to try to time the bottom. After all, if they can invest when a stock price has plummeted, they may be poised to make significant gains when it goes back up. While it’s tempting, you need to help them understand the risk of a false bottom. A false bottom occurs when people believe that a bottom, or temporary low, has been found in a stock or other asset only for the value of the asset to continue falling further.

“The biggest danger is that you’re wrong – either way,” says Cameron Jeffreys, senior vice president at Global Atlantic. “Timing markets is incredibly difficult, and you can miss significant moves in the markets, both ways, in your attempt to do so.”

Recent false bottoms

The dangers to your clients of trying to time the bottom of a market and believing in brief rebounds were evident earlier this year. The stock market rallied in July after a near-historic decline during the first half of 2022. However, the rebound was short lived. In September, blue chip stocks reached their lowest level since 2020, according to The Washington Post.² Analysts were ringing the warning bells of such a “bear market rally” as early as August. Forbes reported³ that it was likely that we had yet to reach the bottom of the market because a few key indicators hadn’t been reached yet: rising unemployment, lowering interest rates, and a slowdown in profit estimates. This up-and-down nature creates an environment where it’s hard to know if we’ve hit the floor.

“Markets are volatile, they seem to be far more whipsaw – they go down a lot faster than they used to and they come up a lot faster than they used to – makes it difficult to time a bottom,” Jeffreys says.

Look back even further, and bear market-bounces have happened consistently throughout history. Analysis from Bloomberg⁴ points out that, since 1974, big turnarounds have come only after the Fed has slashed rates, something which, they believe, is not likely to happen anytime soon, so it’s important to remind your clients that they should not be convinced that we’ve hit the bottom just yet, especially if the false “all-clear” of July 2022 is any indication. History can’t predict future events, but according to Jeffreys it can offer important context when looking at market performance.

“If you look at the last five or six bear markets going back 50 years, it averages a 35-40% drop in the S&P 500,” he says.

Having the talk

It’s important for you to talk to your clients about the specter of the false bottom — and maybe talk them out of trying to time the market. Walking them through a volatile market is difficult, but there are a few steps you can take to help prevent them from getting too overzealous about the opportunities or anxious about the risk. Jeffreys says there are three things to remember when having the discussion about see-sawing markets.

• Be honest. First and foremost, you should be up front about the reality of the situation “Being honest and saying, ‘Yes your portfolio is down ‘x.’ Hopefully it’s not down as much as the equity market if there’s a good diversification plan in place.”
• Don’t overreact. “Markets go up and go down, you don’t want to overreact in either direction,” Jeffreys says.
• Talk about opportunity. Instead of trying to time the bottom of the market, try to discuss the opportunity. “If you can put some historical context around where we are relative to other moments in time, it can ease people’s fears that the world is coming to an end – because it’s not.”

How annuities could factor in

Given how volatile the market has been, trying to time the bottom is a risky endeavor. Plus, with rising interest rates, once-safe bets like certain fixed income products aren’t as safe a place to retreat for your clients as they may have been previously. One of the ways to mitigate the risks of a bumpy market and spiking interest rates, Jeffreys says, is to encourage your clients to diversify their portfolios, not only from an asset allocation standpoint, but also from a product allocation perspective. Fixed index annuities (FIAs) can provide a sense of security during a period of instability, especially to investors who are more averse to risk. Additionally, a registered index-linked annuity (RILA) may be an attractive option as well for those with a bit more appetite for risk.

“With a RILA, you get a little more upside potential – you have to bear a little more downside risk – but given where the markets are today relative to historical averages, combined with the buffer, RILA’s may look attractive to certain individuals.”

Past performance is no guarantee of future results. Investors cannot invest directly in an index.