In her book Juggling Dynamite, money manager Danielle Park, points out that an investor who avoided the 10 worst days of the market would have posted returns of 5.9% and 59% in 2002 and 2003 compared to -24.2% and 26.4% for a buy-and-hold investor in the S&P 500. She says:
In fact, history shows that investors who avoid the big market downturns need only capture 30% of the next upmarket cycle in order to fare just as well as perpetually invested and therefore more risk-exposed buy-and-hold investors.
Numbers such as these make it very difficult to argue that there would not be lasting benefits were investors able to step out of markets and avoid the bulk of the ugly price corrections and the resulting losses.
There are two questions that average investors need to ask of any investment philosophy that promises more reward (for the same level of risk) or less risk (for the same level of reward) when compared to a stock index:
- Has it worked in the past? Is the after-tax return (adjusted for risk) better than simply buying and holding the index? Is there any reason to believe it will continue to work in the future?
- Can the average investor successfully follow the investment strategy?
Unfortunately, market timing fails both tests. I don’t know the track record of Ms. Park’s strategy for market timing compared to the S&P 500 (let alone a diversified portfolio) but we do have some evidence about how successful market timers are as a group. According to Mark Hulbert, who tracks market-timing newsletters, roughly 80% of newsletters under perform the market indexes. John Bogle, as you would expect, has a devastating opinion on market timing:
In 30 years in this business, I do not know anybody who has done it successfully and consistently, nor anybody who knows anybody who has done it successfully and consistently. Indeed, my impression is that trying to do market timing is likely, not only not to add value to your investment program, but to be counterproductive.
Even if you believe that market timing works, you have to decide if you’ll be good at it. By definition, market-beating strategies are hard to practise because if everyone can do it, they will have acted on it already and ironically, it won’t work anymore.
The choice for average investors is clear: buy-and-hold a diversified portfolio of low-cost funds and rebalance regularly. Let’s say that an unlucky investor with a 75% exposure to equities, invested a lump-sum just as the market was peaking in 2000. At the end of 2006, he would have earned an annualized return of 3.6% during one of the worst bear markets in history. The good news is that unlike the unlucky investor, we save and invest periodically, in bull and bear markets and our returns are likely to average about 6% even in a low-return environment.
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22 responses so far ↓
1 MillionDollarJourney.com // Jun 21, 2007 at 7:37 am
I think that in a sense, most investors market time. For example, right now the markets are high, so a lot of people are moving their money into cash or waiting for the correction to spend their cash. When you purchase stocks at a bargain, isn’t that market timing?
2 Phil S // Jun 21, 2007 at 7:42 am
As I said before, there’s a fine line between value investing and market timing. One example is during the height of the tech boom. Nortel was trading at triple digit P/E ratios and I wouldn’t touch that stock with a 10′ pole. Unfortunately, I was also a believer in indexing at that time and I believe that Nortel made up 30% of the market cap of the TSX index at that point in history and I still got slaughtered in the ensuing crash.
I equate stock picking to shopping. Why would you pay more for the exact same item if you know that on your NEXT shopping trip, whether you’re off to cross-border shop or go to Walmart or Canadian Tire or whatever, you can buy that same item cheaper? So if we equate it to the investing world, why should I buy, for example, one of the big 5 banks right now at a 14 P/E when it historically trades at maybe a 12.5 P/E and you think it will get back down to that normal level when interest rates start to rise?
The one important thing to note is that I’m not a seller, though. As a fundamental investor, my investment time horizon is effectively “forever” like Warren Buffet, assuming that the fundamentals of the business doesn’t change. Right now I’m happy putting all my new money into cashable GICs, waiting for buying opportunities to pop up. Especially now, since I can get over 4% guaranteed on that cash on these short term fixed securities.
3 FourPillars // Jun 21, 2007 at 7:50 am
I think market timing works perfectly - 50% of the time.
Mike
4 Canadian Capitalist // Jun 21, 2007 at 9:03 am
You could argue that waiting in cash is a form of market timing. To me, market timing is strategically moving between cash and equities and that is the definition in the book as well.
MDJ: Which market are you talking about when you say “markets are high”? IMO, REITs and emerging markets are overvalued, TSX maybe fully valued. Canadian investors can still find relative bargains in US and EAFE equities and bonds, now that yields have spiked.
5 Investoid // Jun 21, 2007 at 9:05 am
Market timing definitely “works”, the question is can you do it? Quant shops around the world look for mispricings and capitalize on them (or lose big) on a daily basis.
The question is, can average investors efficiently time the market? Do they see the signs that point to a downturn? Evidence shows that typically they do not, and while history is a good lesson and guide, rarely do you see the exact same circumstances twice that cause a bear market to rear its head.
An interesting backtest would be to run a strategy which invests in the index and that pulls out money based on relatively higher market performance over a yearly or other periodic basis, and puts money in when the opposite occurs, with quarterly or yearly rebalancing.
6 Canadian Capitalist // Jun 21, 2007 at 9:12 am
Investoid: Exactly! Even if it works (I have my doubts), what chance does the average investor have? How do you know when a bull or bear market has ended? Are there flashing lights or blaring sirens to tell you when to get in (or out)? What about the added friction of taxes and costs?
7 MillionDollarJourney.com // Jun 21, 2007 at 9:14 am
CC,
The markets that I think are over heated are: TSX, NASDAQ and Emerging markets. Do you move money into cash when you feel that markets are “fully valued”? Or do you just sit and wait it out?
8 Canadian Capitalist // Jun 21, 2007 at 9:23 am
MDJ: I don’t consider NASDAQ a “good” index. It is a mostly a sector fund. Even for what I think are overvalued markets, I just don’t put new money in. Selling and then buying at a lower price is a tough game to play.
9 hepman // Jun 21, 2007 at 9:38 am
I’m currently 25% cash (GIC’s, some cash), 10% bond, 15% int. equity, 50% can equity. I’m thinking of selling some of my can holdings and then buy up more foreign holdings. Is it market timing if I do this when the Canadian market is “fully valued”.
10 KS // Jun 21, 2007 at 9:51 am
CC, you said that “Even for what I think are overvalued markets, I just don’t put new money in.” Isn’t that market timing?
I thought most index investors buy on regular intervals whether or not the market is overvalued or undervalued. Is that true?
11 Phil S // Jun 21, 2007 at 9:52 am
The big difference is your investment time horizon. If you’re the type who is trading for short term capital gains, then I agree that it’s impossible to guarantee success on market timing.
In my case, I am a long term investor. The only times I have sold investments is when I was taken out by a takeover or when our incompetent government got in and started meddling where they shouldn’t have been.
When I purchase an investment, I consider their P/E ratio, their dividend yield, their past track record and of course the industry that they’re in. If I’m happy with all of the above, then I’ll buy it. If I’m happy at the price that I got into the stock and the dividend yield at that price, then I really don’t care if the price dips in the short term because I know I got in when it was cheap from a P/E ratio standpoint. Sometimes I only buy 1/2 of my intended allocation of that stock so that I can add to my position if the price falls right after I buy it, as Murphy’s Law tends to happen more often than not (markets always overshoot, in both directions).
Anyways, at this point I think we’re all just discussing personal investing philosophies. And it’s perfectly OK to have differing opinions, after all that’s what makes a market! You have to love free market economies!
12 ThickenMyWallet // Jun 21, 2007 at 9:59 am
Your post reminds me of something that a professional trader once said to me: “you win in inches and lose by feet in day trading.” On a practical basis, most average investors don’t have the time or liquidity to move in and out of the market consistently (not to mention the tax implications of doing so outside of a tax deferred account).
Our collective attention spans are too short now. Most of the successful investors in the world buy and hold. Why go against the grain?
13 Jason B // Jun 21, 2007 at 10:44 am
Isn’t what Investoid proposed described in the book Value Averaging by Edleson?
14 Rob // Jun 21, 2007 at 11:21 am
Comments like…
“an investor who avoided the 10 WORST days of the market would have posted returns of 5.9% and 59% in 2002 and 2003 compared to -24.2% and 26.4% for a buy-and-hold investor in the S&P 500. ”
…drive me crazy.
The flip side should be obvious (but never seems to follow) that the investor who avoided the 10 BEST days in the market would have relative results that are just as dramatic, but underperformed the market and lost considerably.
Granted, this is only a quote and I have not read the original work so maybe the obvious follow-up is written just as prominently the actual book. Frankly, I doubt it and whenever such an obvious follow-up fact is omitted, I immediate discount the value of the author to almost zero.
15 Big Cajun Man // Jun 21, 2007 at 12:16 pm
Funnily this book is nowhere to be seen in the Ottawa Public Library? That is silly!
Yes, if I had a time machine I’d be the best investor in the world, where is Sherman and Mr. Peabody when you need them.
–C8j
16 Growth in Value // Jun 21, 2007 at 12:24 pm
To me this is a question of semantics.
If you know when the market is about to take a serious turn and can trade accordingly, then market timing is great. But most people can’t actully do that. They just think they can. They point to one lucky instance of buying at the bottom or selling at the top to justify their skill. I’ve done it once myself by accident (Nortel) and I’m not attributing it to anything but dumb luck.
So in short, market timing is a great strategy if you can actually time the market. I just don’t think anybody can on a large scale over a long time frame.
17 FinancialJungle // Jun 21, 2007 at 12:40 pm
How does one define market timing? Technical analysis? Value investing? To me, TA is clearly market timing, but value investing isn’t.
A technical analyst attempts to time the peaks and valleys of the market with no regards to the intrinsic value of the stocks. Remember that market price doesn’t equate the intrinsic value. A value investor buys and sells based on fundamentals and valuations, with no regards to market’s peaks and valleys. For example, a value investor will take a pass on an over-valued stock even though the momentum is pointing upward. The value investor will buy a stock when market price
18 Sol Veritas // Jun 22, 2007 at 1:52 am
Phil S: “When I purchase an investment, I consider their P/E ratio, their dividend yield, their past track record and of course the industry that they’re in.”
Hey folks, what ratios and triggers do you guys use for these numbers?
19 David // Jun 24, 2007 at 8:25 pm
“an investor who avoided the 10 worst days of the market would have posted returns of 5.9% and 59% in 2002 and 2003 compared to -24.2% and 26.4% for a buy-and-hold investor in the S&P 500.”
Like Ms. Park, my retroactive investments in the market have had spectacular returns, far out pacing the indexes. However, my returns are entirely imaginary, as, I expect, are Ms. Park’s.
As stated elsewhere, choosing to be out of the market on those 10 disparate days would be a great challenge.
David
20 Book Review: Juggling Dynamite // Jul 9, 2007 at 11:35 pm
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