Buy-and-Holders disdain market timing. What if everyone listened to them? If there were no market timing, there would be no stock price changes.
Q2 2020 hedge fund letters, conferences and more
If every investor stuck with one stock allocation at all times, there would be no sales or purchases of stocks. It is sales and purchases that make a market. If the Buy-and-Holders had their way, the thing that we now call a stock market would cease to exist!
Timing is the means by which participants in the market adjust to change. A new source of oil is discovered and lots of market participants are affected. Prices are lowered, sales increase, workers are hired, some companies gain market share and other companies lose market share. Do we call it “timing” when a company elects to lower its reliance on electricity and increase its reliance on oil because oil prices have fallen? I have never heard that term used to describe that sort of decision. But that’s what it is, isn’t it? Isn’t the company that elects to use more oil in those circumstances doing the same thing as an investor who buys more stocks when the CAPE value drops?
We have all heard so many times that market timing never works that we have come to believe that it is somehow a negative thing to do. But this is silly. An investor who times the market is changing his allocation so that it fits the new circumstances that apply in a new time. It is the intelligent allocation of resources that makes markets work and to change one’s allocation in response to changed circumstances is the intelligent thing to do. Market timing is essential.
How Did Market Timing Get Such A Bad Name?
The confusion has its roots in the Rational Man concept in Economics. Economists have never demonstrated that consumers or investors make rational choices. They have assumed it to facilitate their analytical models. But the reality is that all human actors are at times highly irrational. Irrational stock prices are something that investors need to react to, just as companies that make use of oil and other energy sources need to react to changes in oil prices. But the false assumption that investors are rational led economists to believe that market timing is not necessary, and, since there are costs associated with timing, that belief causes investment analysts to discourage the practice.
And here we are.
There’s always going to be market timing going on because the market couldn’t continue to function without it. But the widespread disdain of market timing has made it hard for market participants to make intelligent timing decisions. When stock prices are low and as a society we are giving ourselves credit for possessing less wealth than we really do possess, we all should be encouraging market timing. But the social taboo against doing so stops us from doing that. And for a time we all live more impoverished lives than we would if we could simply acknowledge that we have mispriced stocks and need to make purchases and thereby push the price up. And of course we collectively make a mistake in the opposite direction when we overprice stocks, as we are doing today.
The idea that market timing is not required caught on because the penalty for failing to engage in market timing is often long-delayed. Shiller encouraged investors to lower their stock allocations in 1996, when stock prices first reached dangerous levels. But most of the investors who ignored his advice feel today that they have done the right thing. They may change their minds following the next price crash. But 24 years is a long time. Many of today’s investors cannot remember the last time when failing to engage in market timing proved to be a big mistake.
Market timing is the most natural thing in the world. It is responding to changed circumstances with a change in one’s investment positioning. I wish that the word “time” had never become a pejorative. To time is to take action in response to change and that is what markets are all about. There always will be market timing but I look forward to the day when we can all speak more forthrightly about what types of timing are most effective rather than fussing over whether timing is a good thing or a bad thing. Timing is a good thing. Timing is what keeps the market alive.
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