I wrote last week about Wade Pfau’s recent comments that earlier in his career (this is when he was working with me on our research showing the benefits of long-term market timing) he believed in market timing but that he now believes that it stopped working in 1996. I don’t believe that. Wade is correct that stock prices have remained at super high prices for a longer time since 1996 than ever before in the history of the U.S. market.
Q2 2020 hedge fund letters, conferences and more
Explaning The The Strange Price History
My problem with the idea that how the market works changed in 1996 is that no one has ever offered an explanation for what happened in 1996 to cause that change to take place. The alternative explanation of the strange price history that we have seen since then -- that investors have become more emotional in the post-1996 years -- makes more sense. Buy-and-Hold has never been pushed harder than it has been in recent decades. And we reached the highest CAPE value in history in January 2000. That told us that something strange was going on. Prices always return to fair-value levels. But it makes sense that it would take longer for that to happen following a time when prices reached levels never seen before.
Market timing is an exciting idea that was rejected in haste. That’s my take.
When I read the article in which Wade offered his recent comments, I was struck by the way in which the interviewer from Morningstar phrased his question. He asked whether investors should be lowering their stock allocations when stock prices get too high in an apologetic way. He wondered “or is that too much like market timing?”
When the question is phrased that way, it is as much a statement as a question. The suggestion is being made that the person responding to the question had better not endorse market timing. If he does, he will be placing himself outside the widely shared belief that market timing is a terrible idea. I don’t mean to pick on the interviewer from Morningstar. This way of setting things up is commonplace. People who work in this field don’t explore the benefits of market timing. Most believe that, to do that would be the equivalent of questioning whether the earth revolves around the sun rather than the other way around.
The difference is that there is a mountain of evidence that the earth revolves around the sun and not a scintilla of evidence that market timing doesn’t work. Smart people believe that market timing doesn’t work. But not because there is evidence that this is the case. The idea that market timing does not work is the product of a tragic mistake.
Examining The Positive Side Of Market Timing
Prior to the publication of Shiller’s Nobel-prize-winning research, experts in this field did not appreciate the need to distinguish short-term market timing from long-term market timing. Research was published showing that short-term timing doesn’t work and it became the convention to state simply that timing doesn’t work. Then a feeling set in that, given how many investors had been told that and given how much harm had been done to them in the event that it wasn’t so, it would be too embarrassing to too many people who work in this field to show that the unfortunate “finding” was a dangerous falsehood.
And here we are. Even a researcher who a number of years back was very excited about his finding that engaging in market timing permits an investor to dramatically reduce risk while also dramatically increasing long-term returns now has doubts because -- Because why? I do not believe that it is just that timing has not provided good results over the past 24 years that has caused Wade to doubt the concept. That reality certainly played a role. But I think that the killer is that there are so few other researchers celebrating market timing. We humans are social creatures. We are all influenced by what others say about our work. If we all encouraged those who explore the positive side of market timing, we would see a lot more research examining the positive side of market timing. Right now, making the case for market timing places one on a lonely road.
The old Wade said that: “Market timing provides significantly higher returns at a comparable level of risk.” And that: “the market timer enjoys a far less risky strategy.” And that: “the findings for market timing are so robust anyway that it hardly matters how we do it.” And that: “the maximum drawdown from market timing is much less. That is how far the portfolio drops from past highs to current lows. The Buy-and-Holder once experiences a 60.96 percent drop, whereas the worst drop for market timing was 24.6 percent.” And that: “on a risk-adjusted basis, market timing strategies provide comparable results as a 100 percent stocks Buy-and-Hold strategy but with substantially less risk and the same average asset allocation as a 50/50 fixed allocation strategy, but with much higher returns.”
If he changed his mind, he obviously needs to say different things. But if social pressures played a role in the change-of-mind, we all lose out on hearing a more balanced presentation of the case for and against market timing.
Market timing is an exciting idea that was rejected in haste at a time when all of the research needed to develop a fully informed view was not yet available to us.
Rob’s bio is here.
