A lot of well-known money managers strongly believe that it is not possible to time the market - that is, to predict whether stock prices will go up or down on any given day.
But if this is indeed impossible, how can anyone reliably invest money in the market? Value investors Howard Marks (Trades, Portfolio) and Seth Klarman (Trades, Portfolio) have both addressed this question.
Don't try to predict the future
In a talk at the CFA Society of Chicago, Marks stated that his Oaktree Capital does not try to time the market. At the same time, a key tenet of the firm's philosophy is to invest on the basis of market cycles. So what is the difference between the two?
"Market timing means raising and lowering cash based on a prediction of what the market is going to do. And we don't raise or lower cash, and we never make a prediction of what the market is going to do… Never know where we're going, but we sure as hell need to know where we are. I do not believe in forecasts. Our investment decisions are not driven by macro forecasts. We don't have an economist on staff. We base our decisions on where we are in the cycle of the business. But knowing where we are doesn't tell us what's going to happen tomorrow, because from any point on the cycle, the market can go up, down or flat."
Knowing where a business is in the market cycle doesn't tell you whether a stock will go up or down, but it does tell you whether it is overvalued or undervalued by the market. Bear in mind that the fact that a business is underpriced does not mean that it will go up in price tomorrow. But that doesn't mean that you shouldn't invest, since eventually prices will reconcile with economic fundamentals.
Always be insured
In his book "Margin of Safety," Seth Klarman (Trades, Portfolio) takes the same position as Marks:
"No one knows whether the economy will shrink or grow (or how fast), what the rate of inflation will be, and whether interest rates and share prices will rise or fall. Investors intent on avoiding loss consequently must position themselves to survive or even prosper under any circumstances. Bad luck can befall you; mistakes happen."
Klarman goes on to point out that people buy flood insurance even if the likelihood of flooding is low. Knowing where you are in the market cycle is similar to knowing whether or not it is likely to flood - if stocks are expensive relative to historical levels, that may be a sign that the waters are rising.
Disclosure: The author owns no stocks mentioned.
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