The Buy-and-Holders tell us that market timing is not really necessary, that it doesn’t even work. And, for the most part, we accept that as reasonable. We don’t think through what it would mean for investors to refrain from market timing.
Staying The Course
To refrain from market timing is to stick with the same stock allocation at all times. Buy-and-Holders call this Staying the Course. I don’t see it as Staying the Course at all. If the risk associated with investing in stocks was the same at all times, sticking with the same stock allocation really would be Staying the Course. But of course that’s not the case. Shiller showed that valuations affect long-term returns. So the risk associated with stock investing is greater when prices are high. To Stay the Course in a meaningful way, investors must lower their stock allocation when prices rise to super high levels in an effort to keep their risk profile constant.
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There will never be a time when all investors buy into the Buy-and-Hold injunction against market timing. It just makes too much sense for investors to adjust the extent of their participation in the market in response to changes in the market’s risk level. But millions of investors do follow the Buy-and-Hold injunction. Millions of investors set their stock allocation one time and from that point forward don’t even think about making changes to it. Today’s CAPE level of 30 would be a logical impossibility if that were not the case.
A market is a community of individuals engaged in buying and selling. It is a living thing. Each transaction affects all other transactions. Today’s buys have an effect on tomorrow’s buys and today’s sells have an effect on tomorrow’s sells.
But that’s not so for the Buy-and-Holders. The Buy-and-Holders will be buying the same amount of stocks tomorrow and next week and next month and next year regardless of how today’s buys and sells go. For the Buy-and-Holders, the market is NOT a living thing. It is a fixed thing, an unchanging thing, a dead thing.
The genius of any market is that it adjusts to change. The market for oil makes adjustments when new oil is discovered or when other energy courses become cheaper or more dear or when geopolitical realities change to make the supply of oil more steady or less so. That’s what the “no market timing” edict destroys for the stock market. The stock market should be adjusting to changing circumstances too. But how can it when so many investors have vowed to buy the same amount of stocks regardless of the price charged? The “no market timing” injunction transforms the stock market into something less than a true market.
Those adjustments need to be made eventually. Investors can try to follow the Buy-and-Hold injunction. But to fail to adjust to changed circumstances is to deny reality. Sooner or later reality demands to be heard. This is why we see such crazy price drops in the stock market. When a large number of investors finally acknowledge the need to change their stock allocation, a whole big bunch of market timing takes place in a short amount of time and we experience a crash. A price crash is deferred market timing, stock allocation changes that have been put off and put off and put off until so many of them happen at once that the entire economic system is put in a state of shock.
Engaging In Market Timing
I think it would be better for us all to engage in market timing as it is needed. We should all aim to maintain the same risk profile at all times, which would mean lowering our stock allocation in response to big upward price swings and increasing it in response to big downward price swings. The more market timing we engaged in, the more quickly prices would self-regulate and the less dramatic price swings would be. A market with less dramatic price swings is a more stable market, a less risky market, a more profitable market. A better market.
The unfortunate thing is that the feedback loop in the stock market is so slow. There is a strong penalty that follows from the failure to engage in market timing. But often that penalty does not apply for long stretches of time, five years or ten years or even longer than that. So investors forget and come to view the Buy-and-Hold dogmas as reasonable. It is only by looking at research that examines how the market operates in the long term that we can see clearly how important it is for all of us to be engaging in market timing on a regular basis.
Market timing is how we come to terms with new circumstances. It is like the steering wheel on a car. There are times when turning the wheel to take a hard left makes all the sense in the world. There are other times when that is the worst possible thing to do. No one would listen to a driving instructor who told drivers to always hold the steering wheel in the same position, to “Stay the Course” with one’s driving choices. As the result of a strange and unfortunate set of historical realities, we have been led to believe that that sort of approach is a perfectly sensible way to steer our stock market. I don’t buy it. Like any other living force, the stock market needs to be governed. It is the responsibility of all investors to keep the market on course. We achieve this goal though the effective use of market timing.
We shouldn’t be talking about whether to engage in market timing or not. We should be talking about how best to go about it. We will see amazing advances in our understanding of how stock investing works when that becomes the primary question on the table.
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