An Exploration of Timing the Market, and What You Can Do Instead

Daniel J. Greenblatt, CFA® BY: Daniel J. Greenblatt, CFA® 01.22.18

Economist John Kenneth Galbraith famously said, “We have two classes of forecasters: Those who don’t know – and those who don’t know they don’t know.”

His words underscore a popular issue in investing–timing the market.

As the current bull market nears its ninth year, clients commonly ask us “what should I do about it?” Since the bull market began on 3/9/2009, the S&P 500’s total return has exceeded 370%, small cap equities (S&P Small Cap 600) have returned more than 470%, and international equities (MSCI EAFE) have “only” returned 190% as of 12/31/171. Following the investing adage “buy low, sell high”, your gut tells you it’s time to get out of the market. Exacerbating these fears, industry pundits are constantly predicting major corrections in the stock market.

Market Timing: The Problem with Forecasting

Investor obsession with market forecasts is understandable. Successfully timing the market can be enormously profitable and has launched many investment managers into stardom. The problem with forecasts is that even the experts are not very good at them!

According to billionaire investor Howard Marks from Oaktree Capital Management, successful investment forecasting requires the following2:

1. The forecasts have to be sufficiently different from the market consensus.

2. The forecasts must be consistently accurate.

3. The forecasts must be timely.

Achieving these three objectives can be difficult, and the task is made more complex after you consider external pressures with which forecasters are typically faced. For example, if a mutual fund manager makes a contrarian prediction that ends up being incorrect, performance will suffer on a relative basis to that manager’s peers. Investors will likely withdraw funds, which will lower the fund manager’s compensation, and may eventually lead to him losing his job. Alternatively, the manager could make a consensus forecast and maintain his lifestyle with relatively little worry. These types of dynamics create a strong incentive for forecasters to not stray very far from their peers, even though these are the types of predictions that provide the least value.

The Track Record of Forecasters

There have been numerous academic studies that test whether the experts can successfully time the market. On average, it has been found that the following groups have failed to time the market3:

For individual investors who often trust their “gut”, the results are even worse. According to Dalbar, the average annualized investor return in equity funds was 3.66% vs. 10.35% for the S&P 500 from 1986-2016. While there were other factors that led to their underperformance, Dalbar concluded market timing was the primary reason4.

So, What Should You Do? – Marketing Timing Alternatives

Instead of trying to time the market, we tell our clients that they should focus on other aspects where they have more control and where their probability of success is potentially higher. These other opportunities include:

While we do not believe that markets are perfectly efficient, timing the market is difficult at best. At Lake Street, we focus on the aspects of investing that we can control and plan accordingly for those that we cannot.

Sources:

1. FactSet

2. https://www.oaktreecapital.com/docs/default-source/memos/1996-07-22-the-value-of-predictions-ii-or-give-that-man-a-cigar.pdf?sfvrsn=2

3. https://www.vanguard.com/pdf/s700.pdf

4. https://www.forbes.com/sites/johnbuckingham/2017/04/03/the-cost-of-market-timing/#491f5b2932ab

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