We have complicated the concept of market timing. We think of it as this difficult, rarely employed, tactical move. For the typical investor, trying to engage in market timing is like trying to finish a marathon. He knows people who have done it. He can imagine possibly doing it someday. But it is not high on his list of priorities. He can also easily imagine reaching the end of his investing lifetime without once engaging in market timing.
That is entirely the wrong spirit.
Q2 2022 hedge fund letters, conferences and more
The Most Ordinary Of Actions
Market timing (changing one’s stock allocation in response to a big swing in stock prices for the purpose of keeping one’s risk profile constant over time) is the most ordinary of actions. To engage in market timing when buying stocks is like accepting the deal offered on the McDonald’s app that gets you two quarter-pounders for the price of one. There’s nothing complicated about it. There should be no controversy attached to it. Why would one NOT want to obtain two quarter-pounders for the price of one? What’s the downside? Why would one NOT want to keep one’s risk profile constant over time? What’s the downside?
Market timing has become controversial because there was a time when it was not properly understood. There was an academic construct (The Efficient Market Hypothesis) that suggested that investors set stock prices rationally and that therefore market timing is not required. Robert Shiller published research in 1981 showing that the market is NOT efficient and, if we all were thinking clearly, we all would have become market timers at that time. But our understanding of this matter has become terribly confused and so there are experts in the field who question the need and even the value of market timing to this day. If we are going to persuade millions of investors to take up the practice, we are going to need to simplify how it is done.
Market timing is not some unusual act that is only performed in unusual circumstances. It is the exercise of price discipline. Shiller showed that stock investing risk is not stable but variable. For the individual investor to keep his risk profile where he intended it to be, he has to diminish his participation in the stock market when the risk associated with investing in stocks increases dramatically. That’s all there is to it. He doesn’t need to guess when prices will turn. If he adjusts his stock allocation properly, he benefits on the day the allocation change is made regardless of what happens to stock prices on that day. The benefit is obtaining the proper risk profile. Down the road, maintaining the proper risk profile will lead to dollar-and-cents gains. But the purpose of market timing is achieved at the moment that the proper risk profile is obtained.
The Essentiality Of Market Timing
Market timing is so essential to effective stock investing that it should become a habit for all investors. We don’t wake up each morning and wonder whether we should brush our teeth or not. Of course we will brush our teeth. It would be unthinkable not to do so. We don’t ponder whether we should aim to eat balanced meals or not. If we do, we probably are not eating them. The best way to eat is just to naturally aim to eat balanced meals at all times. You won’t always succeed. But, if that is always the goal in mind, you will succeed as often as not. That’s what matters. Eating balanced meals is a healthy habit that one should all aim to maintain at all times. Like market timing.
There is no negative to market timing any more than there is a negative to brushing one’s teeth or to eating balanced meals. One can get any of those things wrong. You might not brush your teeth long enough. Or you might not possess a clear understanding of the nutritional value of a particular food and thus end up eating more of it or less of it than would be ideal. That of course happens with market timing. We don’t know everything about the subject. So it is possible for an investor to over-react to a price shift. Market timing can be executed in a slightly wrong way. The key is that it be engaged in regularly. If you regularly engage in market timing, you will get the hang of it in not too much time. You will make some mistakes and you will learn from them. Practice makes perfect with market timing much like it does with so much else.
When market timing is being practiced by the vast majority of investors on a regular basis, we will all be hearing reports on how to best go about doing it on radio shows and in magazine articles. The report at the top of the hour might note that stock prices rose another five percent this week and that therefore those who have not lowered their stock allocation since the beginning of the year had better not forget to make an adjustment in their stock allocation to reflect that change before too much more time passes. The more often we are reminded of the importance of market timing, the less strange and scary an experience it will be for us.
I often observe how stock prices are self-regulating so long as most investors are engaging in market timing. Prices rise above their fair-value level because investors possess an urge to obtain something for nothing. The higher prices bring the long-term value proposition of stocks down and informed investors lower their stock allocation a bit to reflect that change. Those sales bring the price down back to where it should be. It all works so nicely so long as we all remember to brush our teeth each morning and to aim to eat balanced meals!
Rob’s bio is here.
