Investing & Retirement

JL’s Self-Defeating Prophecy: Markets (Don’t!) Always Recover

JL – if you ever end up reading this and feel like I’ve been a jerk, please let me know. It’s not my intention, and don’t want to besmirch your golden reputation. And yes, in writing this article I did hear the famous lines of Michael K Williams’ (RIP) Omar Little echo in my fingers“When you come at the king, you best not miss”.

JL’s the king. I hope my point is on target.


Jesse in a time machine?? No, this is JL Collins!

JL Collins seems like a great dude. He’s 99%+ correct about every investing topic. He helps a ton of people and he’s a great writer. Go buy his book.

But he’s wrong about this one thing. But first, a tiny backstory.

Last week, I wrote about the idea that it’s “impossible to lose” in the stock market (spoiler: it’s possible). And regular reader Accidentally Retired wrote in and said, “Jesse you need to read this quote from JL Collins…”

JL once wrote:

The market always recovers. Always. And, if someday it really doesn’t, no investment will be safe and none of this financial stuff will matter anyway.

JL Collins

AR: thanks for sending that to me. But I take exception. Everyone: deep breath.

This statement—made by JL and echoed by countless others—is a self-defeating prophecy. The more people who believe it…the more true they want it to be…the more dollars wagered on this idea being true…the less likely the statement will hold water in the long run.

Why?

Let’s start with one of Burton Malkiel’s famous quotes from A Random Walk Down Wall Street:

If we knew that a stock would go up tomorrow, why, it would just go up today.

Burton Malkiel

Malkiel is describing the notion of “pricing in” the future value of an asset into it’s current price. The more confident we are about the future, the more accurately today’s price will reflect that presumed future. Read that again. And then let’s apply that idea to market recoveries. The more confident we are that markets will always recover, the more likely today’s price will already account for that presumed recovery.

How would this actually play out? How does the market “already account for that presumed recovery?” It gets confusing, and quickly.

If markets always recover, then the recovery would always be priced in. Thus, they’d never drop in the first place. If stocks never drop, then they’re guaranteed to only increase. If they only increase, then there’s no risk involved in investing. If there’s no risk, then there shouldn’t be a return. And if there’s no return…well, what’s the point of investing?

Whoa. That’s circular. But circular in the way that M.C. Escher’s Waterfall is circular. We end up where we started, but while turning the world upside-down.

The more people who believe JL’s claim, the more likely claim will render false in actuality.

Instead, we need to realize that the risk of permanent loss is one of the driving factors behind stocks’ returns. “Guarantees” lessen those returns.

I don’t begrudge J.L. for his statement at all, because it’s a paradox.

People doubting that markets will recover is synonymous with, “Markets are risky.” If stocks are deemed risky, investors will demand higher rewards. Over time, any diverse stock portfolio would see high enough returns to sufficiently recover from any correction.

This would play out over and over again, as we’ve seen throughout stock history. This is why markets have always recovered in the past!

But as soon as faith in those recoveries becomes too universal, the market would never drop in the first place—after all, who would ever sell knowing that recovery is guaranteed? If no one sells, prices don’t fall. No fall, no recovery.

It’s pretzel logic. A self-defeating prophecy. But it’s a fun, tiny nuanced idea that I think ought to intrigue not only JL and his readership, but anyone else curious about markets, risk, pricing, and our investment future.

Thank you for reading! If you enjoyed this article and want to read more, I’d suggest checking out my Archive or Subscribing to get future articles emailed to your inbox.

-Jesse

P.S. – If you enjoy podcasts, check out the Best Interest Podcast! It’s getting some rave reviews!

About Jesse Cramer

Jesse Cramer created The Best Interest to explain personal finance and investing in simple terms. His writing has been featured by CNBC, MSN, The Motley Fool, and other national publications. He resides in Rochester, NY with his girlfriend and their dog. Follow him on Twitter: @BestInterest_JC
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1 thought on “JL’s Self-Defeating Prophecy: Markets (Don’t!) Always Recover

  1. Oh man! What have I done?!?!!

    But in all seriousness, I do agree that this is a paradox of sorts IF everyone believed this and thought long-term. However, the fact is that most do not.

    When markets plunge, the average investor pulls their money out at the wrong time. And conversely when markets are soaring, they pour more fuel on the fire. In essence, they manage to do the opposite of the age old advice of “Buy low, Sell high.”

    So, I have no concerns of all investors getting on the same page. If humans could truly think long-term and with common sense, we could have a problem on our hands, but I do believe that markets will always recover as long as humans continue to behave and be manipulated by various short-term circumstances and incentives.

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