This blog is inspired by recent client comments about the certainty of a market plunge when Congress is unable to avoid a big mess around the upcoming debt ceiling negotiations. The thought, then, is to take money off the table now, and then buy everything back as soon as prices plunge. But let’s dissect this before we leap.
Timing the market is treacherous. First, what you think might happen, might not. This happens a lot and makes market timers fail to achieve good returns. Second, if you make a timing move and you are right (usually by accident), then you tend to think you are going to be right in the future, if you do the same thing you did last time. So bearish investors who are “right” because they sold, nearly always resort to selling. They never switch sides and try to “time” the upside. A balanced approach to the strategy is the only way that will work, unless you want to become an expert on one stock or commodity and spend your days trading only that one security. Then you might have enough knowledge to trade in one direction. Third, let’s say you hit it right when you sold and stocks tank. Now you have to buy back in. But the moment at which stocks have tanked is when the news will be the worst. Will you really have the fortitude to buy into the bad news?
I’m not saying market timing can’t be done. But like finding life on Mars, it has yet to be achieved.
Now let’s look at a couple historical examples. First, the last debt crisis. Negotiations on the 2011 debt crisis started in earnest in May of that year. From May 2 to August 2 when a deal was signed, declines in the Dow of over 100 points occurred as follows: May 5, 11, 13, 23; June 1, 10, 15, 24; July 11, 27; and Aug 2, the day of signing. The rest of the time, the Dow was either UP over 100 points, or traded in double digits like usual. On May 2, the Dow closed at 12,807. On Aug 2, the day of signing, the Dow closed at 11,866. The decline from May to early August of 940 points amounted to 7.3%. And since the deal was struck, you’d think it was time, then, to jump back in. If you did that, you muffed it, because August was the month when S&P decided to lower the rating of US debt, and volatility and down days increased markedly. In fact, the remainder of the summer and the first part of the fall was pretty crappy.
If you had called it right and sold out in May, you might have saved 7% after commissions (assuming you also owned Dow-like stocks and they fell in similar fashion). If you pay taxes, your savings would be cut by any capital gains realizations and the resulting tax liability. But: you had to get back in. If you didn’t buy in the face of the tumbling Dow, you missed the recovery move that started in October of that year. Getting in, of course, incurs more commission costs. Also, while you sat it out, you earned no income on your “investment”. Cash pays zero, while the Dow paid around 2.6% per year back then. But let’s just say you were able to save yourself a net 5% that time around. Is it worth it? Would you kick yourself if you had been wrong and the risk you took around being out went against you? There are a smattering of days in market history when the market has dropped 5% in a single day, with a rebound occurring nearly immediately. Nearly every calendar year contains a market correction of 5% to 10% with the “norm” being about 7%. So that 5% savings doesn’t seem like hero material.
Notably, if you bought an S&P index fund on Jan 1 of the Debt Ceiling Debacle Year, and went to sleep, you woke up on Dec 31 that year with a 2.11% return. Not really a disaster.
Now let’s look at the fiscal cliff negotiations. It’s hard to say exactly when the worry started over the fiscal cliff, because it was a backdrop issue all year. The first actual proposal on the table came November 29, 2012. But when we scan market returns for the year, we see a lot of volatility starting in October. So we’ll use Oct 1 as our start date. From Oct 1 to Jan 2, 2013, the first business day after something was signed, the Dow dropped 100 points or more on October 9, 10, 19, 23; Nov 2, 7, 8, 14; and December 21 and 28. Some of those declines were over 200 points! And yet: from October 1 through January 2, the Dow lost only 100 points, or a measly 0.7%. That was then obliterated in the next few trading days.
No return from market timing to speak of there. And using the Rip Van Winkle approach in 2012 – buying at the beginning of the year and awaking at the end – earned you 16.0%.
Then there was the sequester. The sequester was a result of the fiscal cliff legislation. Concerns abounded that the economy would tank. Shouldn’t you get out of stocks in response? Well, no. As sequester din was rising in early 2013, the market surged – did it ever. January brought one of the strongest starts ever for the market in any calendar year.
The astute reader will pick up a pattern. It appears that at first, Congressional misbehavior made the market go down. Then in 2012, when we had another bout of idiocy in D.C., the market was volatile, but really didn’t go anywhere. By the time the sequester rolled around, investors were yawning and apparently gave it no thought. This adaptive response is typical of markets. Participants learn to deal with repeated events, eventually ignoring them.
Look back on Greece. At first, stocks swung wildly as Greece went to the till over and over. Now we just ignore it. It’s still happening – but markets “don’t care”.
Adaptive response makes it very difficult to know if markets will care about the upcoming debt negotiations or not. Maybe if other uncertainties about the Fed, the taper, the economy, whatever, are mixed in, yes. But otherwise, be careful where you place your bets!