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The Science of Hitting
The Science of Hitting
Articles (644) 

Another Lesson on the Perils of Market Timing

Some thoughts on market volatility over the past six months

April 03, 2019 | About:

On December 24th, the S&P 500 closed at 2,351. From a high in late September of 2,930, the index had declined nearly 20%. What was shaping up to be another strong year a few months earlier now looked like it would end with a decline of more than 10% for the index. In addition, between talk of trade wars and weakening economic data, the risk of further losses seemed heightened. If we imagine ourselves back in December, here’s what you would’ve read if you picked up a newspaper like USA Today (edited for brevity):

The stock market entered the holidays on a grim note, with the Standard & Poor's 500 stopping short of bear market territory and on track for its worst December since 1931.

The plunge on a shortened trading day came as President Trump doubled down on his criticisms of the Federal Reserve and after attempts by the U.S. Treasury secretary to reassure markets unsettled investors instead.

The Standard & Poor's 500 lost 66 points, or 2.7%, to close out Monday at 2,351. The Dow Jones Industrial average dropped 653 points, or 2.9%, to end at 21,792. The tech-heavy Nasdaq, which fell into official bear territory on Friday, lost 140 points, or 2.2%, to finish at 6,193. The Russell 2000, an index of small-company stocks that's also in a bear market, ended down 2.0%, at 1,267.

"There’s a lot of political unrest," said Jimmy Lee, CEO of the Wealth Consulting Group. "And when you have uncertainty and a lack of confidence in leadership, it makes investors nervous and it has. They run to safety."

The moves come after Trump reportedly discussed firing Federal Reserve Chairman Jerome Powell, blaming the recent turmoil in the stock market on the central bank's Wednesday hike of a benchmark interest rate and its rate outlook for next year.

On Sunday, Treasury Secretary Steve Mnuchin announced that he had called the chief executives of the six biggest U.S. banks to ensure they had enough liquidity to operate normally. The unexpected move rattled investors.

Also adding to the political chaos was Trump's removal of Defense Secretary James Mattis before the general's planned departure, along with the continuing partial shutdown of the federal government.

There’s not much there to inspire confidence. In addition, with endless talk in the financial press over the preceding quarters about the longest running bull market in history, it was only natural for people to wonder when the party would come to its inevitable end. The average individual might have taken this confluence of factors as a sign that they should reduce the amount of equity exposure in their portfolio – or even get out of the market entirely.

But what has happened since shows just how dangerous this thought process can be. In the last week of 2018, the S&P 500 climbed by roughly 7%. In the first quarter of 2019, the total return for the S&P 500 was another gain of roughly 14% - the best quarter for the S&P 500 in a decade. As of Tuesday’s close, the S&P 500 is only 2% lower than the highs reached in late September. In total, it has returned 22% since Christmas Eve. Individuals that cut their equity allocations in December based on recent market volatility or due to concerns about macroeconomic and political developments have paid a steep price for doing so.

In addition, they’re left in a precarious position. Most of the concerns mentioned in the USA Today article (or the endless number of articles just like it at that time) either remain with us or have been replaced by other issues (that’s not surprising – the future is always uncertain, and there are always risks to consider). Now these individuals have to answer a very difficult question: What should I do now? Do they capitulate and repurchase the stocks they sold a few months ago at prices that are 20% higher, or do they want for something else to happen before they get back in?

I can feel for them: If I was in their position, I would have no idea how to intelligently answer that question. It's for that reason that I decided a long time ago that I have no interest in playing that game. I mostly came to that conclusion by listening to investors who are a lot smarter and more experienced than I am. As I've built up my own experience in this business, I’ve also seen how the market timing strategy has worked for these individuals in real time. Here's what I've concluded so far: Over the past ten-plus years, I’ve seen an endless list of people try to jump in and out of the market – and as far as I can tell, none of them are better off for having done so.

To be clear, this isn’t a call to own stocks at any price. It’s also not a suggestion for you to invest with your eyes closed. Instead, it’s an endorsement for an asset allocation that focuses on an appropriate mix of stocks and bonds based on your willingness and ability to bear risk – and to largely stick with that allocation over time. In my view, there is almost no scenario where an individual should make huge changes to an appropriate allocation. If the “right” mix for you is 60% stocks and 40% bonds, you should try to stay near that target throughout the market cycle. A corollary to that is if a 60% stock allocation is too much to handle during bouts of market volatility, the answer isn’t to try and get ahead of downturns --it’s to allocate much less than 60% of your portfolio to stocks (the simple truth is that some people do not have the temperament to live through the inevitable bouts of volatility they will face if they invest for long enough). Those that failed to adhere to those simple principles at the end of 2018 have learned an expensive lesson.

What’s in store for us over the remainder of 2019 is anybody’s guess.I think anybody who is focusing their attention on trying to predict what will happen in the coming months is playing the wrong game - or at least a game they’re much less likely to win at long term than the alternative.

Disclosure: None.

About the author:

The Science of Hitting
I look to high-quality businesses for the long-term. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with the top five positions accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

Rating: 5.0/5 (7 votes)



Stephenbaker - 1 year ago    Report SPAM

Science, agree wholeheartedly with not timing the market with existing positions. Have to disagree somewhat when it comes to new money; I prefer to wait until stocks are decidedly cheap with tailwinds at my back and then only buy the best of the best.

The Science of Hitting
The Science of Hitting - 1 year ago    Report SPAM

Stephen - So to play devil's advocate, let's say you came into some new money in 2011 or 2012. At what point were stocks "decidedly cheap" from there? Immediately? How about in 2014 when the S&P 500 was up ~50% from 2011 (very rough numbers)? And do you go from 0 to 100 the day that happened? Always curious to hear how others think about this. Thanks as always for the comment!

Stephenbaker - 1 year ago    Report SPAM

Science, stocks are only one part of an [my] overall investment portfolio. When it comes to allocating money, I only buy assets when they are decidedly cheap, no matter whether they are stocks, bonds or alternative investments. Admittedly, in the last 5+ years, nearly all asset classes became expensive. That is why it is helpful to have a "side gig" in which you can comfortably invest excess funds when other investment classes don't make a lot of sense. For my $, a side gig needs to offer better than money market rates of return; it should be an enterprise in which you have extensive interest and knowledge; something local in which you maintain control of funds, and that creates liquidity so that when other assets get cheap, you have funds available. The amount of risk you take is up to you but I prefer very low risk for such an enterprise. I began allocating funds in a side gig more than 20 years ago and not only has it grown significantly, it has provided the described benefits in such a way that my hurdle rate of investing in stocks is much higher than merely having a cash alternative for excess funds.

Bruceps - 1 year ago    Report SPAM

Stephenbaker's response offers an interesting add-on, i.e. his side gig. Any suggestions what this would entail?

Stephenbaker - 1 year ago    Report SPAM

Bruce, what you do is up to you. To analogize with lemondade, the single lemonade stand I started in the late 1990s has grown to more than 40 locations that all produce monthly income. All earnings have been retained and reinvested other than for payment of income taxes or allocation into stocks on two occasions, once in 2000 (though the amount purchased was relatively small since the enterprise was in its early stages) and again in 2009 when a large amount of cash was allocated into equities. Most people have one or more interests and skills that can be used for purposes of making money. I assume that most folks here enjoy investing and probably have more knowledge and ability than average. A side gig or enterprise can transfer those skills and abilities into an enjoyable investment something other than stocks or bonds.

Bruceps - 1 year ago    Report SPAM

thank you.

Thomas Macpherson
Thomas Macpherson premium member - 1 year ago

Great stuff as always Science. I think I wrote about it once before, but my first experience in stocks (and market timing) was a competition in middle school where we each of us were given a fake $1,000 and told to invest in any stocks we wanted. I found the cheapest one I could find in the newspaper stock quote page (I mean...you get more stocks when they are cheap right?) and purchased something like 25,000 shares. The first day I went up 15% the next day down 25% then up 15%. You get the gist of it. After 28 days I had lost 88% of my $1,000 and sold all my shares. I came in last in the competition. There were so many lessons to be learned in that exercise, but one was certainly never, ever market time. On an interesting note: the winner was a kid whose father said just hold the cash beause the markets were rigged and you couldn't trust Wall Street. So there you go.

The Science of Hitting
The Science of Hitting - 1 year ago    Report SPAM

Tom - Great story :) Thanks for the comment!

Jtdaniel premium member - 1 year ago

Hi Science,

Very nice article. I agree that rebalancing (reacting to what has already occurred) to an established ratio of stocks to bonds and/or cash is more likely to work out better for most investors than market timing (speculating on short-term market direction). A classic example is Vanguard Wellington, which regularly rebalances to maintain an approximate ratio of two-thirds stocks to one-third bonds. Wellington has rebalanced its way to a 8.28% average annual return since 1929 -- not bad for the retiree focused on income, safety of principal and a low expense rate (0.25%).

As an individual investor I choose to rebalance at a much slower pace than Wellington, especially in taxable accounts. In 2017/2018 my portfolio was up, but my largest stock holding (Exxon-Mobil) kept sinking. My simplistic analysis was that the price of oil and natural gas would eventually increase and Wall Street would quickly jump onboard. If I had sold XOM at the end of 2018 and held the proceeds in cash, I would have missed a 21.53% gain so far this year, forfeited a nice dividend and paid long-term capital gains tax. I think this is what Mr. Buffett means when he advocates inactivity in portfolio management. Best, dj

Gperfusion - 1 year ago    Report SPAM

I did the opposite, I put 100% of my 401k into MA at about 185, rode it down a little then up to 235 until I made back all I lost at the end of 2018. I have a history of selling too soon. Sold AAPL at $8 in 1997 dooh. I always get extremely aggressive when the market goes nuts. Bought 40,000 shares of Ford at 2.50 in 2008 debacle. Wished I'd bought Priceline. I looke at it like this, my retirements ruined, so why not make a big bet on a single quality stock that I trust?

Debylguy - 1 year ago    Report SPAM

well......I'm still relatively new to all of this... however, on 2nd October 2018 i kept on looking back at 2007 and wondered why i shouldn't just get completely out of the market and buy back in if it started to go up.. i did this and it was the best thing i ever did. I got out on the 2nd after having lost $70,000 and really enjoyed knowing that I would have lost far more if i had stayed in. I got back into the market soon after christmas and have recoved my $70,000 lost as well as made an extra profit of $30,000 (on Australian tech stocks (which are doing better than the american ones - APT, ALU, APX, Z1P etc.). So what is wrong with getting out when the whole market is panicking? It isn't panicking on my part. It is taking advantage of the panic, and also taking the precaution that the drop MAY be like 2008. I would really appreciate some advice... everyone seems to say to not panic.... stay in.. .i don't see the logic. Share buying and selling is so flexible ... I'm not a day trader... I just look at what is happening and try to use logic.

Jtdaniel premium member - 1 year ago

Hi Debylguy,

I think the decision turns on whether the investor views a falling market as a selling opportunity or a buying opportunity. Only in hindsight do we know far or how long a market or stock will descend. The best I can do is hold some cash (33% now) and keep a watch list of a few stocks I really want to own at a value-based target price (e.g. ABEV - buy at $3.50). If ABEV falls to $3.50 my only decision is how much to buy, because in a crash there are are likely to be other good options on my watch list. This all sounds simple, but the waiting can be excruciating.

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