Market Timing

And I’m back.

I know. You have not had any material to read when you wake up at 3:02 am and cannot go back to sleep. Well this topic today should put you to sleep in fifteen minutes.

Ready. Go.

Everyone in the financial industry talks about market timing. Is it possible? Are there professionals that can time the market consistently? Are those that have timed the market just lucky?

Let’s start with defining market timing. The definition itself is rather ambiguous. Generally, market timing is buying (or selling) the market (say S&P 500) right before the market (S&P 500) is about to go up (down). Personally, when I hear market timing, I think VERY short term…like within days and weeks. Once you start hitting months, I see it as tactical/strategic asset allocation as opposed to market timing. Therefore, based on my definition, I don’t see any professional being able to “time the market” on a consistent basis. Otherwise, all investors would invest with that individual/company. [Sidenote: going forward in this article the word market is synonymous with the S&P 500. ]

I implicitly left open that perhaps one could be able to look out months, or years, and have a general feel of where the market is headed. What do I mean by this?

I think there are several indicators that can be used to signal that the market is under/overvalued. I won’t delve into those indicators now (but there are a lot of good ones). However, these indicators cannot predict (in my opinion) with consistency very short term – daily or weekly – movements of the market. To use a temperature analogy, the indicators can gauge how cold, lukewarm, or hot the market is…but they cannot tell you the specific Fahrenheit degree. Sticking with the analogy, the inability of indicators to tell the specific degree is in direct agreement with the famous Keynes statement that, “The market can stay irrational longer than you can stay solvent.”

One of the best pieces on that topic is from the people at Gestaltu. They found that over a long period of time, it’s better to hold onto the market even when the market is in the 80th percentile (meaning at that point in time, the market has only been more expensive 20% of the time so one would think it’s pretty overvalued) than to sell the market when it crosses the 50th percentile.

The market goes up longer than one would expect, and the market goes down further than one would expect.

That was a short tangent.

So what am I trying to say?

To repeat, indicators can give warning that the market is going to drop (let’s be directional here and focus on drawdowns) in the upcoming months or years.

“How is that any good?” you may ask. “I’m supposed to ‘sit in cash’ for months, or years, and just wait? Wait on the sidelines?”

Yes, exactly. You are supposed to wait, and be patient. Sit in cash? No, do not sit in cash. Earn a conservative 2% by investing in treasuries. Then, when the market reverses and tanks (say 20%) then you earn 2% from income + say another 5-6% in the treasuries appreciating + you miss a 20% correction. That’s a total return of nearly 30%!

You may not like the idea of “sitting on your hands,” but look at the below chart. I looked at the largest pullbacks in the S&P 500 since 1950. I used the time periods based on Wesley Gray’s numbers here.

drawdown final

The goal of the chart? Look how far back those losses took the market. Obviously, the largest one is the 2007-2009 recession. It destroyed your gains as far back as April of 1997! That means you could have placed your money under your mattress from April 1997 until February 2009 and you would be no different (monetarily, not emotionally) than someone who invested in the market that entire time. There was another crash that was almost equally as devastating to your gains back in the early part of the ’70s. And the dot-com crash wiped out more than five years of gains.

My point is NOT to convince you that I’m a bear investor (I am definitely not), but to emphasize patience when the market is pretty overheated. Going back to my temperature analogy, the water is pretty hot right now. My opinion? There is a much higher chance that the market will drop 20% than will go up 20%. I don’t like the current risk/return probability. Where can I obtain a 30% return (since that’s  what everyone wants!)? Sit in treasuries and wait for the correction/pullback/whatever you want to call it that will (probably) come in the next 12 to 24 months. It’s a similar concept of paying down debt that is charging you 5%, or sit in cash. You are “earning” 5% by paying down that debt…though it does not feel like it.

And if it doesn’t come? You earned 2%. You learned some discipline. And you learned to never trust me. Jk.

P.S

Just so people don’t think I’m a bear investor, I’m tempted to have my next article focus on the speed of the recovery AFTER those losses from the above chart occurred, as I think they are occur much faster than you may believe.

 

Adam McCurdy, CFP®, EA

As always, this if for informational and educational purposes. Nothing contained herein constitutes tax, legal, insurance or investment advice, or the recommendation of or an offer to sell, or the solicitation of an offer to buy or invest in any investment product, vehicle, service or instrument. What has worked in the past may not work in the future. Past returns do not guarantee future results.

Adam McCurdyMarket Timing

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