Wednesday, June 29, 2016

On Market Timing - Part One

“Buy Low, Sell High.”

Perhaps the most persistent fantasy in all of investing is selling a profitable position at the very top of its market cycle and buying it back at the bottom.  You keep all the profits, avoid all of the losses and look really smart. 

I can’t time the markets like that.  I feel a little better that some great investors have said the same thing.  There are people who can time broad financial markets but none of them have ever called to tell me how they do it.  When someone does offer to share their proprietary market timing strategy, we count the silverware.

Over the next three blogs I’m going to explore market timing; why it’s so hard, why we keep trying and what the average investor should know.  These are just my experiences and not the definitive work on the subject.  I hope you enjoy them and share them with recovering market timers.

Even I call tops and bottoms once in a while. 

Once doesn’t count.  You have to get the “buys” lower than the “sells” and you have to do it more than half the time.  The shorter the cycle you’re timing, the less you can be wrong. 

This is a chart I created that tracks two elements of the S&P 500 index.[1]

The blue line shows the earnings of the index going back to 1980.  Since this index represents about 80% of the US stock market, it’s a good proxy for our economy.  The bumpy ride reflects rough and smooth patches in our national financial health.

On the positive side, earnings in 1980 were about $15 a share.  Last year they topped $85.  That’s better than a five-fold increase and doesn’t include some handsome annual dividends.
Look at the blue line as a child with a yo-yo climbing stairs.  She drops and returns it with every step. 

If you measure yo-yo volatility by the step, the swings from high to low are huge.  If you measure it by the whole staircase, the yo-yo is much higher at the top than the bottom – even from the high on the first step to the low on the last.

The blue line was the easy one.  The red line is the price/earnings (P/E) ratio.  That’s the blue line divided by the price of the index. 

Over the long-haul, stock prices reflect earnings.  Day-to-day, prices are whatever investors are willing to pay for those unknown earnings, or the economy, or politics or their mother-in-law or whatever else consumes them at the time.  Their actions range from disciplined to blind panic.

To be a successful timer using only those two variables means correctly anticipating future earnings and understanding how investors will feel about them when they happen.  You also need nerves of steel and the discipline to take gains and losses without emotion.

A very famous continuous study by the Dalbar Company[2] called the “Quantitave Analysis of Investor Behavior” (QUIB) shows most investors do anything but “buy low and sell high”. 
They buy at tops.  They sell in panics.  They chase what’s hot.  They listen to their brother-in-law or, lately, internet gurus.  Then they do it all over again.

Ego plays a part.

Men always think they are great poker players and stock pickers.  I’m reminded of the old saying, “if you are playing poker and can’t spot the sucker in five minutes, it’s you.”

Individuals playing against institutional traders are up against formidable resources. 

We offer complimentary 12-step market timing withdrawal therapy with every new account.  I’m serious.  You know how you’ve done.

Next week I’ll talk about why we still try to time the markets anyway.  Thanks for visiting and I’ll see you then, sh

The opinions expressed here are those of Skip Helms and do not necessarily reflect those of LPL Financial or anyone else. It is not possible to determine the top or the bottom of the market. Investing involves risks, including the loss of principal. Past performance does not guarantee future results. Please consider potential transactions carefully and read all appropriate materials before investing or sending money. No strategy, such as asset allocation or diversification assures a profit or protects against loss. Securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA / SIPC

[1] The S&P 500 index is an unmanaged index of 500 US stocks.  You cannot buy an index.  Indexes do not reflect fees, commissions or other costs.
[2] See for their findings and methodology.