Why You Can’t ‘Time the Market’

Mike Williams | 15th February 2016

The Bludgeoning

OK, this quarter has shown us more double-digit down openings over minor crimps in earnings reports than I can ever recall seeing in my career.

But don’t be fooled by all this action.

While it makes my skin crawl to watch a guidance report released with the headline time-stamp of 4:11, and by 4:12 the stock of XYZ Company is down 22%, but you have to put that into perspective.

Call it what you will, but these are not human trading actions.

Algorithms are running through headlines and then running stops in seconds; moving markets, causing confusion and bringing out the emotional beast the next morning.

It's kind of like the mark-to-market plague during '08/'09 which unnecessarily chewed up so many bank balance sheets. This time around, the Feds need to step in and understand what high-speed trading is doing to the average investor.

The 4 Signs of a Bottom

I’ve only sent this message out two times in my career; during the tech lows back in 2003, and early 2009 when the end of the world arrived.

So here are the 4 stages of fear that are generally attached to a low in the markets during corrections:

Stage 1 - Where is my screwdriver?

This is the feeling that begins to seep into your mind as you look at the news reel, get blinded by the devastating headlines and then remember that your windows in your office do indeed open - if you have a screwdriver.

Stage 2 - How the hell did it get there?

This is when you’re finally pushed to find that screwdriver, usually after you’ve just heard more of the never-ending terrible news streaming off your screen. Screwdriver in hand, you cannot believe how quickly the first three screws come out of the window frame holding it closed.

Stage 3 - Damn it’s cold out here.

This is the stage where you find yourself grasping at the concrete edge of the window ledge with your fingers, calculating in your mind how many dollars your account is down today. You say things to yourself like, "Geez-o, at this pace it’ll only take another 14 months to be at zero", as you begin to realize just how cold it is in winter…while outside…on the ledge.....looking all the way down to your carport 12 feet below.

Stage 4 - The world really is ending.

You start to think ‘they’ were right, then close your eyes and relive all those headlines - all the guys who said Black Swans were real, that they ‘knew the top was in when....’. Then just as you feel yourself letting go you think of one more smart move. One more idea that is sure to cause you to turn the corner.

You Decide to be a Market Timer

Bearish sentiment has soared.

We have fewer bullish investors now in all the polls than we had at the last two bear market lows.

And all those ‘experts’ selling you that fear are clear: “The bear is here, get out of the market.”

The perils of market timing grasp everyone during these times, “Hey I can just sell now and get back in lower.”

But the idea that you can time your way through, miss all the carnage and then just buy when the coast is clear, is a fantasy.

The coast only looks clear at higher prices after a usually sizable rally that seemed impossible at the time.

Beware the perils of market timing.

Any time the market experiences sudden sharp selling pressures like we’ve seen over the last few weeks, two things almost always happen:

1. Bearish, ‘sell everything’ headlines and stories appear like crazy, and

2. Investors undergo the behavioural process of strongly considering selling their stocks (or, worse, they actually do it).

Don't get me wrong. I want to take the plunge each time I see a rally fail and more stops getting run in the market. I know exactly what you’re feeling.

And it’s understandable why these reactions hang around downside volatility like pests.

The media knows these moments are an easy road to increased viewership as the crowd turns to their fight or flight survival instincts, often without ever really knowing it.

But remember this: Every single low is set when that last person leaves. It’s said that market lows witness empty trains leaving the station, while market tops have cars loaded to the gills going off the cliff.

And yes, I know - hearing all that right now after these last 6 weeks is enough to make you angry. And that means it’s working - emotions are tugging at us, fooling us into believing something we cannot see: Fear.

By the way, have you ever noticed that when the market moves to the upside - at the same pace and distance as a downside move – no one ever uses the term ‘volatility’ to describe it…

Back to the Point

The moment an investor capitulates is the moment that investor becomes a ‘market timer.’

And what has history taught us about even the very ‘best’ market timers?

They’ll get it wrong more often than they will get it right.

So why do investors choose this path?

Our emotions and brains are electrically charged to abhor losses twice as much as we rejoice in gains, and that emotional imbalance often gets the better of us. We fool ourselves into thinking the best way to prevent more losses and remove uncertainty is to sell. History shows us this is one of the great jokes of investing in stocks.

The crowd feels its decision to liquidate assets under the presumption that they’ll be able to reinvest again once stocks resume their rise is logical.

But, that mind-set is flawed. History proves it repeatedly, year after year, correction after correction.

The Fallacy of Market Timing, In Numbers

In a study conducted by DalBar, covering the period from 1995-2014, the following data show the annualized returns by asset class - relative to the average investor:

Stocks: +9.9%

Bonds: +6.2%

International stocks: +5.0%

The average investor: +2.5%

Inflation: 2.3%

So what was the primary issue faced by the investor crowd?

Market timing.

Under the fallacy of ‘selling what’s not working and buying what’s working,’ investors were switching in and out of funds at inopportune times.

After two bear markets in the last 15 years, it’s easy to be frustrated and fall prey this tactic. But as Dalbar shows, the process actually hurts investors. And not by a small margin.

Missing 'Up' Days by Fearing 'Down' Days

Being out of the market on just 10 of its best days can kill long-term compounding.

It’s why you either; go into a correction with cash and are prepared to use it, or you ride it out for the long-term - which, as noted above, is the only way to obtain long-term equity returns.

The data shows the S&P 500 from January 3, 1995 to December 31, 2014, where $10,000 invested would have grown to approximately $65,500 (+9.9% annualized).

But, here’s what happens to your $10,000 investment when you start missing some of the upside:

Missed the 10 best days: $32,665 (+6.1% annualized return)

Missed the 20 best days: $20,354 (+3.62%)

Missed the 30 best days: $13,446 (+1.49%)

And, then it turns negative from there.

So what about the value of being out of the market on the worst 10 days?

Well, that would also produce a higher total return. However, getting that decision right probably means sacrificing most or all of the good days you need to produce that higher return.

By example, six of the best 10 days occurred within two weeks of the worst 10 days.

It’s arguably much easier to participate in the good days than to avoid the worst days because the stock market rises a lot more than it falls.

And therein lies the terrible truth:

In order to realize long-term annualized growth rates you have to stick with stocks when it feels ugly - like now - through the good times and the bad.

As we have often said: Investors assume risk in order to obtain long-term reward. Without risk, there is no reward. Believing otherwise is a fantasy.

The Bottom Line for Investors

Plan first. Set standards. Cash is there for your short-term goals/needs. And for long-term wealth building foundations you have to be able to take the good with the bad in order to enjoy the returns.