Does market timing work?
Most stock investors would answer “no” to that question.
There are some who try it from time to time. They get a feeling about which way stock prices are headed and they indulge the feeling by taking some money off the table or by adding some to the pile. If you quiz those investors, you will find that even a good number of the investors who engage in market timing don’t do so with a great deal of confidence that it will pay off.
There is often an “aw, shucks” attitude toward the market timing project in evidence. The thought is that it might work and it might not. Efforts in market timing are rarely rooted in sound, systematic thinking. It’s usually a feeling that inspires the decision to increase or decrease one’s stock allocation for a time.
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Bogle's Views On Market Timing
Most experts discourage the practice. John Bogle, who was my second favorite investment analyst (Robert Shiller is in first place for me) when he was alive, used to express his views on market timing in a colorful way. He would say that not only did he not know anyone who engaged in market timing successfully, he did not know anyone who knew anyone who engaged in market timing successfully.
So the case is closed. Right?
Not right.
Not by a long shot.
Shiller has described the intellectual leap from the finding that short-term price changes are unpredictable (University of Chicago Economics Professor Eugene Fama showed this in research published in the 1960s) to the Buy-and-Hold belief that the market sets prices properly as “one of the most remarkable errors in the history of economics.” The idea that there might be circumstances in which market timing might not work is rooted in this false Buy-and-Hold belief, this “remarkable error.”
The many investors who have doubts about market timing are not entirely wrong. Fama really did show that short-term price changes are unpredictable. So short-term market timing really does not work. Short-term market timing is taking guesses about the direction in which prices will he headed in the next six months or the next year. If the Buy-and-Holders only found fault with that form of market timing, they would be performing a public service by doing so.
But the more important form of market timing, the approach to market timing that always works, is long-term market timing. Long-term market timing is changing one’s stock allocation in response to a significant change in stock prices for the purpose of keeping one’s risk profile constant over time.
As Shiller suggests, the market often does not set prices properly. When it sets prices improperly, the risk associated with stock investing increases and investors seeking to keep their risk profile constant over time (which should be all of us) need to adjust their stock allocation to do so.
Short-Term vs Long-Term Timing
Most investors fail to distinguish short-term market timing, the kind that never works, from long-term market timing, the kind that always works and that is always required. It’s a national tragedy. Given that there is 41 years of peer-reviewed research showing us all how important it is to engage in long-term timing, every expert worthy of the name should be advocating long-term timing.
A quick look at today’s CAPE value tells you that they are not doing it. The CAPE value could never rise this high in a world in which most investors were engaging in the rational pursuit of their self-interest when setting their stock allocation.
Implicit in a belief that market timing is not required is a belief that stocks always offer equal value. Does anyone really believe that? I don’t believe that there are very many who do. Investors get it that high stock prices diminish the value proposition of stock purchases.
But few appreciate how much the value proposition is diminished when prices reach the level where they reside today because experts in this field rarely encourage them to perform the calculations they would need to perform to assess how much the value proposition is compromised when prices reach scary levels.
We live in the dark re the true value of the stocks we own because we want to believe that the numbers on our portfolio statement are real despite a mountain of evidence that that is very much not the case.
Rob’s bio is here.
