Trying to Time Stock Markets

Investing in the stock-market is ultimately a philosophical exercise. All of our clients know that we are part of the ‘Passive School of Thought’, which means that we believe it is not possible to consistently beat the performance of the overall market by choosing individual or groups of stocks. Similarly, we believe it is not possible to know in advance when you should ‘get in’ or ‘get out’ of the market (i.e. buy or sell) in order to generate greater returns.

In both instances we believe that taking an Active approach leaves the investor worse off over time, and indeed there is considerable research on this topic to show just that. We previously discussed the benefit of Passive over Active in relation to stock picking, so now is a good time to look at the Futility of Stock Market Timing.

Over recent months, the noise from the market (or rather all the vested interests that surround it) has been about the inevitability of a severe correction or downturn in market prices. As such, active investors are taking a more cautious approach and withdrawing their money from these markets and moving to cash or other alternatives. The problem with this approach is that there is no rational science behind it. We often hear about ‘CAPE. or other technical terms that look at a share price versus profit/earnings – (P/E ratio) and a view of what that might mean in the short term.

However the truth is that you cannot predict a market cycle and to do so exposes you to the Risk Of Missing Out. What people often don’t truly realise is the extent to which markets perform in short sharp bursts, either positive or negative.

The below graph is instructive. It shows the average return for a relatively Balanced Fund over a 40 year period while also identifying the worst single day loss for that fund.

As you can see, even in years where the markets have performed really well, there have been days of extreme losses.

Avoiding these loss days is the long held goal of the active manager, but other than staying out of the market entirely, this is next to impossible. The passive investor looks at these days and sees that they are mostly absorbed into the market and don’t have any long term negative impact.

Of course for markets to absorb such large one day losses there must also be days of huge upswings and this is where the the second folly of active management comes into play.

Below is a chart showing the experience of the MSCI World Index (global equities) over the last 19 years, incorporating 2 significant ‘Bear Markets; (2001/02 & 2008/09). There are almost 5,000 working days during this period and the graph shows the impact of missing a small number of them.

Incredibly, by missing just 10 of the market’s best performing days (0.2% of total time) investment returns would be reduced by over 100%, while missing 20 days (0.4%) would lead to a negative overall performance!

What does this Mean?

It means that the focus of Active Managers is often on avoiding those worst performing days highlighted above. Unfortunately little attention is paid to the opportunity cost of also missing the (much fewer) best days. Both are impactful, but to successfully avoid the worst and be present for the best is simply impossible, especially as they are often very close together.

Your best bet as an investor is to stick with the market through good times and bad, because that’s what you get rewarded for. The goal of a good investment advisor like ourselves is to ensure that you do.

 

Talk to us today about Passive Investing.

[Thanks to iCubed for providing the above charts]

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