Market timing success equals long term failure

People just love a good story.

The story of the boy who cried wolf. The legend of Atlantis. The myth of a pot of gold at the end of a rainbow. Who can forget such great stories?  

Even though we know these are just myths, we are fascinated nonetheless.

In investing, the favorite legend is: the myth that people make money timing the market.

People love legends about investors who sold at the top and bought at the bottom. Don’t confirm the facts. Don’t dig into the details. It’s entertainment, after all.

The reality is that people don’t make money timing the market (see my most recent client letter for some background). Even assuming someone gets lucky enough to sell at the top, they never get back in until they’ve lost the advantage they gained in selling. Or, if they buy at the bottom, they sell too soon or too late and lose that advantage, too. Check the facts.

The people who claim to sell at the top or buy at the bottom do worse than buy and hold (as highlighted by Mark Hulbert in the Wall Street Journal, subscription required).

Why do people persist in believing the myth? It’s entertaining. It makes for great cocktail party fodder. People want to believe. 

The reality is that good investing is boring. You save by spending less than you make. You invest it wisely after a lot of study. You initially look stupid. Then, over time, your wealth grows and you become financially independent.

Where’s the pizzazz?! The lasers? The alien invasions? 

Nowhere to be found.

Good investing is not high entertainment. But, becoming financial independent is very entertaining.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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Market timing success equals long term failure

Market timing and market valuation

Excellent article from Morningstar on market timing and valuation.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Market timing and market valuation

Downturn ahead?

With economic data getting worse and markets looking shaky, the question on everyone’s mind seems to be: our we heading into another economic and market downturn?

Specifically, economic and market data in the U.S. are rolling over, Europe seems to be in full-out recession, and China is growing more slowly with its manufacturing sector even pulling back. This makes everyone wish they knew whether recent trends will continue down, or if a rebound (or central bank support) is on the way.

The reason people care is that it makes a BIG difference on short term returns. If the economy and markets roll over, then you want to be in long bonds, which do great under that scenario. If recent numbers are just a head-fake, and we’re going to see growth resume, you want to own stocks and commodities because they’re dirt cheap assuming growth resumes.

But, the above thinking assumes that it’s possible to know whether the economy and markets will turn down or resume growth. Such an assumption is, however, suspect.

Can experts accurately predict either economic or market downturns? Their track record, contrary to popular belief (and the amount of money you pay for it), is terrible.  

Economists and market strategists, brilliant people who parse economic data on a full-time basis, are dreadful forecasters. As a group, they have never–not once–predicted a recession beforehand. 

Individually, most of them are wrong most of the time. Every once in a while, an economist or market strategist “correctly” predicts a recession or rebound, but no one–and I mean no one–gets it right more than a couple of times. 

Keep in mind that a broken clock is right twice a day–that doesn’t mean it correctly tells time. A market strategist who calls for a downturn all the time will look right one third of the time, and an economist who always calls for growth will be right two thirds of the time. That doesn’t make them accurate forecasters, and that won’t help you get into and out of investments at the right time.

If the experts are consistently wrong, maybe the right place to look is the aggregate opinions of millions of market participants.  Do markets correctly predict market downturns or rebounds?  Not at all.  One famous quote is that “the stock market has predicted 9 of the last 5 recessions.” Translation: markets predict recessions and rebounds much more frequently than they actually occur.  Once again, such guidance does investors more harm than good.

Well, if brilliant experts tracking all the data can’t get it right, and the judgment of crowds can’t do it, what’s to be done?  

First off, accept the premise that, at present, no one has figured out how to consistently time markets over the short term. It’s like forecasting the weather–it’s such a complex and adaptive system that no one knows what’s going to happen ahead of time (even though they can tell you precisely what happened in the past). 

If no one can successfully time the market, then don’t try to do it–don’t try switching in and out of stocks, bond and commodities in a failed attempt to get better returns. Channel Nancy Reagan and just say “no” to market timing.

Instead, do what has worked over the long run: buy cheap and sell dear. Instead of spending gobs of time, effort, and money trying to guess market direction, spend your time trying to figure out which companies to buy and then calculating what price to buy and sell them (relative to underlying fundamentals).

It doesn’t work every time, and it won’t necessarily work over the short term, but it does work over the long term with a high degree of confidence.

Avoid the rat-race of unsuccessfully wondering if a downturn is ahead, and focus instead on underlying value. Your results and your psychological well-being will be better for it.  

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Downturn ahead?

Stick to your knitting

There are many ways to invest, but, what’s more important than any particular method you choose to is whether you stick to it.

One fundamental choice is passive or active. Passive investing is investing with the market. This method is agnostic about market value and broadly diversified. It’s low cost and tends to beat most active managers, but can go through long periods of poor absolute returns, like we’ve seen over the last 12 years. If you don’t want to search hard for superior investors and can’t stand being out-of-step with other people, then passive is probably your best approach.

Be careful, though, not to waffle between passive and active. More important than your choice of passive or active is whether you can and will stick to your choice. Those who switch between passive and active do worse than those who stick to either passive or active.

Active is investing differently than the general market in an attempt to beat market returns. This is very difficult to do, but if you can find a superior money manager, it can make a huge difference in your long term wealth. Once again, you must stick with the approach for it to work, and this will be hard to do when your active manager is out-of-step with the market, under-performing the market, and charging you higher fees than passive investing. Once again, if you switch back and forth between passive and active, you will do worse than either approach.

Within active, there are several approaches, too. There’s macro investing: trying to bet on economic trends in the attempt to have exposure to the best sectors or countries. There’s market timing: trying to anticipate market sentiment and buy when things go up and sell before they go down. There’s growth: trying to buy the fastest growing companies to beat overall market growth. There’s value: trying to buy companies selling at the lowest price to underlying fundamentals. Value has the best long term performance, but even it goes long periods of under-performance between bouts of out-performance.  

I’m going to risk sound like a broken record, but it’s too important not to emphasize again: it matters less whether you choose value, growth, marketing timing or macro, and more whether you stick to it. Value may out-perform over the long run, but it won’t work if you try to do it when it’s “working” and try to do the other methods when they’re “working.” The academic and anecdotal research on this is unequivocal, people who try to switch methods at just the right time grossly under-perform those who stick to one method consistently.

I’m a dyed-in-the-wool value investor, I’ll readily admit, because it works better than the other options. To succeed, though, I have to stick to it in good times and bad, not just when it’s “working.”

If you want good investment results, pick your method and stick to it. Though some work better than others, nothing works as poorly as trying to switch between them.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Stick to your knitting

"Going to the sidelines"

Most investors have a recurring fantasy they can dodge market volatility. 

When markets start to tank or look scary, such folks want to “go to the sidelines,” which means parking their money in cash or safe bonds, “until the skies clear.”

When you ask them how they know when to go to the sidelines and when to come back, they frequently tell you they just FEEL it.

To that, I have one thing to say–BALONEY!

Feelings tell you nothing about markets, all they tell you is your emotional state.  Those who use their feelings to guide their investment decisions get nowhere.

Many of these people went to cash in the fall of 2008 or the spring of 2009.  In cash, they have earned maybe 2% returns if they were lucky.  If they had invested whole-heatedly at those times, they’d be sitting on 50% gains or more.  Those feelings don’t look too smart in hindsight.

Market prices tank when people get scared.  That’s when the bargains appear–when people aren’t selling for economic reasons but because of their emotional state. 

The same thing can be said on the upside.  If people feel euphoric–like in early 2000 or late 2007–then it might be time to get more conservative.

Your emotions tell you just the opposite of what to do, so don’t listen to them.

My best investments were made when I was scared.  I normally feel sick to my stomach when I purchase investments with the best upside.  My emotions are terrible guides, and so are yours.

When markets get scary or euphoric, it’s time to look at the data.  What kind of returns will I get given current prices and normalized earnings.  When I get nervous, I look at the data.  When I’m feeling optimistic, I look at the data.  I always look at the data, not my emotions.

For those who think they can go to the sidelines until the skies clear, I wish you the best of luck–you’ll need it! 

If you want to make a bundle on your investments, invest aggressively when you feel scared and get conservative when you’re euphoric.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

"Going to the sidelines"

Market strategist = diaper

One of my favorite Wall Street jokes: How is a market strategist like a diaper? They both need frequent changing and for the same reason.

So, why are market strategists full of…um…stuff?  Because timing the market is a waste of time. 

Each year prognosticators try to guess where the stock market will go over the next year, and almost every year they are off by a mile.  This is more likely to be the case in 2011 because almost every market strategist is bullish.  The only thing worth less than a market strategist’s prediction is a group of market strategist’s predictions–especially when they all agree.

Why are market predictions so inaccurate?  Because the things that most impact market returns over a given year are also almost impossible to predict: 

  • Will North Korea lob nukes at South Korea? 
  • Will Israel attack Iran’s nuclear facilities? 
  • Will bond markets abandon Japanese, European and U.S. bonds en masse driving up interest rates? 
  • Will the European Union fall apart? 
  • Will the world economy continue to recover at its current pace? 
  • Will China engineer a smooth or crash landing in an attempt to slow inflation and real estate speculation? 
  • Will U.S. unemployment dive from 10% to 5%?
  • Will drug companies discover a cure for cancer?
  • Will accurate prediction cease being an oxymoron?

None of these thing is strictly predictable, but if any of them occur (except that last), they’d have a huge impact on markets.  You’d have better luck trying to predict earthquakes and hurricanes (things entirely deterministic and yet experts almost never get annual predictions right).

So, why do people crave such predictions?  Because we’d all like a sure thing.  Wouldn’t it be great to have next year’s newspaper and know exactly what stock prices would be a year from now?  We’d all love it, and the entertainment factory that is called news sells tons of advertising each year knowing we’d all love those answers.

But, those answers are worth what we pay for them–nothing. 

Instead of reading the horoscope in hopes that we’ll be lucky today, we should get to the daily grind of making things happen for ourselves. 

That’s what I’m going to do: resist the temptation to read or make predictions, and instead do research on good investments at cheap prices.  There’s a new year’s resolution that works.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Market strategist = diaper

Rolling over?

The S&P 500 is down 16.2% since April 23. Commentators all over are trying to peer into their crystal balls to figure out if the market is tanking, or just taking a breather before resuming its climb.

Data point in both directions.

The Chinese stock market is down much more than U.S. markets, but state manipulation makes that data point suspect.

Railroad figures continue to look good. They haven’t recovered summer 2008 highs, but they’ve been steadily heading in that direction.

Commodity prices have pulled back but haven’t broken down to levels that would suggest all hope is lost. Copper is below $3, but has paused around that level. Oil prices are over $70, just where Saudi Arabia wants it (suggesting demand is still strong). U.S. natural gas prices have been climbing since late February and are hitting new highs. Asian steel prices have declined since March, but have leveled off above prices of last summer. Dry bulk shipping prices have tanked, but that could be as much due to on-coming supply of ships as lower demand.

The Economic Cycle Research Institute’s (ECRI) Weekly Leading Index has declined to the point of many past recessions, but hasn’t crossed the threshold or time period to make recession certain.

Weekly unemployment claims are below 500,000, but not below the significant 400,000 level that frequently signals the sustained end of recessions.

What’s an investor to do in such situations?

First, remain calm. No one predicts recessions with precision, except in hindsight.

Second, stick to your discipline. If some of your investments look cheap, buy more. If others look expensive, sell some or all. Don’t try to time the market, evaluate prices relative to potential returns and buy when returns look good. You won’t catch the bottom, but no one but the lucky do anyway.

Third, plan to react to up or down side. It’s handy to have a plan instead of reacting emotionally. Feelings are an investor’s worst enemy. Decide what you’d do if prices took off (probably selling) and what you’d do if prices decline (probably buying), and then have the courage of your conviction when the time comes. Don’t change your plans based on how you feel, but on what you rationally think.

Investing is a game where cooler minds prevail. Don’t get emotional and don’t abandon your soberly made plans. In the long run, the next few months will probably look like an unmemorable blip on the computer screen. Invest wisely and you won’t care.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.