Buy-and-Holders don’t believe in market timing. They condemn it at every turn. Their hostility to market timing is rooted in an historical mistake. Eugene Fama published research in the 1960s showing that short-term timing doesn’t work. The Buy-and-Holders jumped to the hasty conclusion that all forms of market timing, both short-term timing and long-term timing, should be avoided.
Long-Term Timing Is Absolutely Essential
The Valuation-Informed Indexers, in contrast, believe that long-term timing is absolutely essential. Robert Shiller’s research showed that valuations affect long-term returns. If that is so, then stock investing risk is not stable but variable (increasing when valuations are high and diminishing when valuations are low). The investor who wants to keep his risk profile constant over time has no choice but to engage in market timing; there is no other way to get the job done. And, when a large percentage of the investing population is persuaded to follow Buy-and-Hold strategies, prices reach insanely dangerous levels because the market is not able to regulate itself when most investors refuse to exercise price discipline when making purchases of stocks.
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Market timing changes every aspect of the stock investing experience.
It affects purchases, of course. I much enjoyed a comment that a fellow made at the Bogleheads Forum when I posted there. He pointed out that no one would walk into a bank and declare “I will take $20,000 worth of certificates of deposit” without first checking what interest rate applied. Yet Buy-and-Holders buy stocks that way all the time. No Valuation-Informed Indexer would buy stocks without first checking what the likely 10-year annualized return is for stocks purchased at that price level. Why would anyone want to make blind purchases? We buy stocks to obtain a return on our savings. What possible reason could there be for making purchases without first checking the return that will apply?
Market timers also react differently to price changes. Buy-and-Holders believe that it is economic developments that cause price changes. So they naturally see it as a positive when prices rise. If price increases signal economic growth, we all should applaud them. But market timers believe that price increases that take the CAPE value above its fair-market level of 16 signal nothing more than irrational exuberance on the part of investors. That’s a negative sign. It tells us that the market is becoming more emotional and less rational. Market timers do not applaud price increases that take stock prices above fair-value levels.
Market Timers And Stock Price Increases
On a personal level, price increases are a mixed story for market timers. They place more money in their accounts, which is a positive. But they lower the long-term return on stocks, which is a negative. The opposite is of course true of price drops. So both price gains and price drops are non-emotional events for market timers. While for Buy-and-Holders price increases are exciting and price drops are depressing.
Market timers do a better job of focusing on the long term. But-and-Holders profess a focus on the long-term. And it certainly is true that Buy-and-Holders pay little attention to the daily ups and downs of market prices. But, since they believe that market prices are determined by economic developments, it is hard for Buy-and-Holders not to be emotionally influenced by big price changes in either direction. The size of an investor’s stock portfolio determines how well he is doing in his effort to finance his old-age retirement. He can hardly ignore big price changes.
Market timers, in contrast, don’t believe that those price changes are real. An investor who doesn’t treat gains that are the product of irrational exuberance as real is not going to become excited to see even more irrational exuberance enter his portfolio or to become depressed to see irrational exuberance that entered his portfolio in earlier years disappear from it. The market timer believes that the long-term average return of 6.5 percent real is the best estimate of the annual economic gain on stocks and tunes out consideration of the higher or lesser gains that he believes are the product of investor emotion. Price gains don’t impress him and price drops don’t discourage him.
Bull Markets Are A Worrisome Thing
Market timers worry more about the economy when prices get high. They see bull markets leading to bear markets and bear markets leading to economic crises. So bull markets are a worrisome thing to the market timer. Bear markets offer the comfort of restoring sustainable price levels. But of course bear markets often cause economic disruptions that affect Buy-and-Holders and market timers alike. Market timers wish that there were a way for stock prices to return to reasonable levels without the economic misery that arrives when the irrational exuberance is popped.
Market timers do not panic during price crashes. They see opportunity in them. They know that stocks purchased at good prices offer an amazing long-term value proposition. Market timers feel cheated when they are forced to lower their stock allocations in response to insanely high prices since their general view is that stocks are an outstanding asset class. They get to make up for those times when their stock allocations are lower than the allocations of most others when they load up on stocks at times when the general irrational exuberance becomes a general irrational depression.
The stock allocations of market timers vary with price changes. But their emotional take on the market is more stable. They don’t get carried away with the highs and they don’t get carried away with the lows. They view the market as offering a steady value proposition that can be obtained at a more appealing price at times when the CAPE is below 16 than it can when the CAPE is above 16.
Rob’s bio is here.