The new administration has ushered in the promise of economic stimulus through infrastructure spending, and tax and trade reform. As a result, the U.S. stock market has gained roughly 10% from the election through the end of March 2017. Yet, despite the generous returns, investors are increasingly suspicious of these political promises and the resulting stock market rally, and are asking about the merits of making a meaningful move out of stocks – until the “inevitable” correction occurs. Geo-political and legislative risks are building, and a growing number of investors see market timing as an appropriate response.
While the temptation of market timing is strong, accurate timing is elusive. Poor timing decisions can significantly diminish long-term investment results, as well as foster a false impression that the investment markets are inherently undependable. On this subject, I read a very interesting November 2016 paper authored by Win Antoons of the Brandes Institute Advisory Board. The following is a summary of his analysis:
- It is far more important to forecast bull markets correctly than to get bear markets correct. Average returns achieved by predicting only 50% of bull markets under performed “buy-and-hold” strategies, even when bear markets were forecasted with perfect accuracy.
- A very small proportion of high volatility days can account for the equivalent of mostly all of long term returns. But a strategy to invest on the “best days” and avoid the “worst days” would be virtually impossible to execute.
- The best and worst trading days are tightly clustered chronologically, so missing the market’s worst days increases the likelihood of missing its best days.
- A disproportional percentage of a total bull market’s gains occur at the beginning of a recovery. Between December 1927 and December 2015, the average gain during the first three months after a market downturn (defined as a drop of 20% or more) was 21.4%. Most market timers tend to be concentrated in cash during the first three months just after a crash.
Long term trends have been against the Market Timer. Antoon’s analysis of monthly returns for the S&P 500 Index from December 1927 until December 2015 shows;
- 12 bear markets and 13 bull markets
- Average bull market gain of 179.8% – average bear market loss of -35.75%
- Average bull market lasted 66 months – average bear market lasted 16 months
- 27% of monthly returns during bear markets were positive
More than market timing, we trust strategic and tactical asset allocation to achieve solid risk-adjusted returns over time. Strategic asset allocation is the process of setting target allocations for various asset classes – based on time horizon, investment objective, and risk tolerance – and periodically re-balancing the portfolio when it deviates from those settings. Tactical asset allocation is an active strategy that seeks to take advantage of price dislocations in the short term.
Certainly, these are interesting times, and the risks may not yet be fully priced in to global stock markets. We fully agree with a strategy to raise some cash, as part of a rebalancing process, to protect a portion of the gains that have been achieved since the election- and we do expect volatility to increase into the spring. However, we are not in a “new normal” and market timing, as always, offers both risk and reward.
Indices mentioned are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results.