The case for timing the market

AN IMPORTANT fact about investing is that there are no indisputable laws, nor is there one correct way to go about it. Within the vast array of different investing styles and strategies, many apparently opposing approaches can succeed at the same time.

According to Investopedia, one explanation for the appearance of contradictions in investing is that economics and finance are social (or soft) sciences — in which “it’s impossible to prove anything”.

“In fact, humans, the main subject of the study of the social sciences, are unreliable and unpredictable by nature,” says the site.

“Just as it is difficult for a psychologist to predict with 100% certainty how a single human mind will react to a particular circumstance, it is difficult for a financial analyst to predict with certainty how the market (a large group of humans) will react to certain news. Humans are emotional, and as much as we’d like to think we are rational, much of the time our actions prove otherwise.

“Economists, academics, analysts, fund managers and individual investors often have different and even conflicting theories about why the market works the way it does. These theories are nothing more than opinions. Some opinions might be better thought out than others, but at the end of the day, they are still just opinions.

“Sally believes that the key to investing is to buy small companies that are poised to grow at high rates. John thinks it would be foolish to risk spending his hardearned money on what he sees as an unproven concept. He likes to see firms that have a solid track record and he believes that the key to investing is to buy good companies selling at ‘cheap’ prices. In investing lingo, Sally is a growth investor and John a value investor. As to which strategy is the better of the two, the answer is neither. There is no reason they can’t both succeed. Each has its merits and aspects that will suit one type of investor better than another.”

The only requirement for success: that you are sufficiently well informed to determine which approach and which theories will suit you best.

The problem, when it comes to investing, is that there is no end of contradictory approaches, advice and theories. Take, for example, those that get bandied about with regard to market timing.

The idea that timing the stock market is futile, if not impossible, is often presented as one of the key truisms of investment advice. No one knows where the market is going at any given time, brokers and gurus say, so the idea is to invest consistently and not worry about short-term ups and downs. Over the long term, the market is sure to rise. The message: you gotta be in it to win it.

But the same people that will tell you that you can’t time the markets will also tell you that market corrections provide great buying opportunities.

Which raises the question: if you can tell a bargain, why can’t you tell when prices seem high?

Not only can you time the markets but you better learn how, says Australian commentator Marcus Padley, if you want to beat average real returns, “which after inflation, tax, management fees, trails, commissions and the index fudge is close to zero before dividends”.

Economist Ben Stein teamed up with investment psychologist Phil DeMuth to examine a century of stock market data and came to the conclusion that you can time the market.

Blindly investing in the stock market whenever you have cash available is not much better than buying a lottery ticket, they claim in their book, Yes, You Can Time the Market, which Forbes described “as a powerful antidote to the traditional notion that market timing is impossible”. Its thesis: the price at which you buy stocks matters a great deal, and it is much wiser to buy when stocks are low than when they are high.

“That sounds obvious enough,” Forbes says, “but it is routinely denied by money managers, investment ‘experts’ on television, and stock brokers, whose interest, as it happens, is to sell stocks (or advice) to the ‘ordinary investor’.

“To prove their case, markettiming scoffers will cite, say, a three-year period when stocks were on the rise, and then note that if you missed, for instance, the five best months out of the 36, your returns would have been much less than if you just stayed in at all times. What’s always left out of such examples is the equally true statement that if you missed the five worst months, you would have fared far better than the standpatter,” Forbes says.

This kind of analysis also suffers for being short-term. Stein and DeMuth insist that over the longer term, 10 years or more, you can benefit dramatically by market timing. “Far from being an irrelevant factor that we should dismiss from our minds when purchasing stocks, price appears to be an extraordinarily important factor that we ignore at our peril.”

Trevor Garvin, head of the multimanager team at Nedgroup Investments, said something similar a few weeks ago when he told a media briefing that they had found and research shows, “that most outperformance is achieved in bear markets; that if you can protect capital in falling markets, even though you might not get all the upside of a market, over time you will end up doing far better as you are coming off a higher base”.

The “father of value investing”, American economist Benjamin Graham, thought price mattered but also advised against “feeling around” for the bottom of the market. “The thing that you would naturally be led into, if you are value-minded, would be the purchase of individual securities that are undervalued at all stages of the security market. But it is not wise to buy undervalued securities when the general market seems very high, because if the general market is going to have a serious decline, then in all probability your purchase will also decline sharply in price,” he said.

“If it sells at less than your idea of value, it does so because it is not popular; and it is not going to get more popular during periods when the market as a whole is declining. Just as (stock prices) go too high in bull markets, they go too low in bear markets … whether that means that a person should avoid a bargain security because he thinks the general market is going down further is another question. Our opinion is that it is better for the investor to have his money invested than it is to feel around for the bottom of the securities market.”

Blindly investing in the stock market is not much better than buying a lottery ticket