In a perfect world, it would be wonderful if you could buy your investments when they were at a low point, then sell them again when their price hits a peak. You only need to look at the wiggly line of stockmarket growth to see how, with hindsight, you would be enormously rich if you were able to get your timing right.
It’s tempting to imagine that this would be quite simple to do. After all, surely it was obvious that the market was about to turn in March 2009, at the end of the Global Financial Crisis, and just as obvious that it was all about to turn sour in December 2019 when COVID first reared its head? If you bought a simple FTSE 100 index tracker on 3rd March 2009 and then sold it on 27th December 2019, you would have made a return of 215.80% – a very nice 11.21% per year (after charges, with dividends reinvested – assuming direct purchase of L&G UK 100 Index fund, class Z Acc).
There are plenty of other examples of how timing the market like this would have made you enormous returns; and not just in the UK stockmarket – global stockmarkets, fixed interest markets and the property market can all provide similar examples, and that’s before we get on to cryptocurrency!
In the same way that alchemists would sell you a secret method of turning lead into gold, there is a host of experts out there telling you how to do this, keen to share their secrets with you.
Yet Sussex Retirement Planning, and most other regulated advisers, will tell you that timing the market is simply not possible. Why is that, when it appears so easy to do?
We don’t actually know why market events happen
The problem with public markets is that there are a lot of people involved in them. This makes them particularly complex systems; forecasting markets is generally agreed to be similar to, but more complicated than forecasting the weather. The weather forecast for tomorrow is usually pretty accurate, but as we stretch that to a week, a month or a year, it become increasingly unreliable. Forecasting the stock market is similar, but less accurate.
And, even after the event, there is usually debate about what caused the change in share prices. Some thirty five years after Black Monday, there’s still no consensus about what caused the FTSE 100 to lose 23% of its value in two days.
So, if we can’t work out what caused a change to occur after the event, what chance do we have of predicting changes in advance?
Both types of volatility happen at similar times
There are two types of volatility of asset prices – upwards and downwards. Volatility is the measure of how wiggly the line on the stock market graph is (I accept that there may be more technical definitions than this!). Everyone likes upwards volatility (when prices suddenly go up) and nobody (apart from journalists) likes downwards volatility (when prices suddenly fall). In a perfect world, we’d be invested when there was upwards volatility, and we’d be out of the market for the downwards volatility. There is plenty of research to show how much better your returns would have been, if you had just missed the worst days.
Research (1) shows that, if you managed to miss the worst ten days in the UK stock market, over a 29 year period, you would have increased your average return by 12.24% per year. However, if you missed the best ten days too, you would only have increased your return by just 0.56% per year. So, logically, you would avoid the worst days and stay invested for the best days. That would be fine if the best and worst days weren’t clustered together. Research from Vanguard (2) demonstrates that most of the best and worst days occur at very similar times; and, usually, when asset prices are in a downward trend. What tends to happen is that share prices fall sharply, and then “correct” quickly.
So, in order to take advantage of volatility, you would need to predict sharp upward movements, be brave enough to invest when markets were already falling and had just fallen sharply, then pull out again immediately after the correction.
We Are Attracted to Bad News
I would have accrued quite a lot of money if I was given £1 every time I was contacted by a client telling me that they had heard that the stock market was about to collapse. I’d have £2 if the same happened when a client told me that they had heard that the market was about to shoot up (I can even name the clients and when they told me – and both of them were wrong!).
In a world in which share prices have tended to go up, this is just not logical. It’s simply because we are programmed to find bad news attractive.
This tendency means that market timers often choose to be out of the market at the wrong time. This is particularly likely in light of the fact that the best days in the market tend to occur when prices are trending lower.
The News is already in the Price
I’m sorry to be the bearer of bad news, but by the time we have read the paper, or looked at the latest economic release, the price of shares has already been impacted by that news. Many trades are automated, and conditional upon what data says, and we couldn’t respond quickly enough to take advantage, even if we wanted to.
Geopolitical events are the type of things that many investors are concerned about. The 2016 Brexit vote is a good example. However, the Brexit vote only caused investments to lose 5.6% of their value; 6 months later, investments had risen by 7% (3). In order to profit, you would have had to call the vote right, sold at the right moment and then have jumped back in before prices rose again.
Cash Usually Underperforms
If this wasn’t the case, nobody would invest in anything else – why would you take the risk of investing? This isn’t just a philosophical point – it has been borne out time and again by evidence. In 21 of the last 29 years, the FTSE World Index has outperformed the Bank of England base rate and it’s looking like 2023 will be another year when investments produce a better return than cash.
The Markets Don’t Wait for Us
Most of us like to have a holiday or a day off, every now and then. Sometimes we are ill. And of course, there may be days when you don’t fancy watching the markets in your retirement – there may be grandchildren to be entertained and memories to make! Sadly, the markets don’t care. They keep on doing what they are doing, regardless of what we are doing. They don’t present a huge number of opportunities for us to profit from their volatility, and, even if we were able to jump out of the market at the right time, we might be otherwise occupied when the opportunity to buy came along.
Is Investment Alchemy Useful in any way?
Traditional alchemy did yield some benefits. After centuries of trying to turn lead and other metals into gold, some useful discoveries were made, by accident, and the science of chemistry was eventually born out of alchemy.
In the same way, the hunt for the secret of market timing has yielded some benefits (other than teaching us that it just isn’t possible to time the market). The resources thrown into the quest for market timing have yielded benefit in understanding collective human behaviour, for example, and they have given us a better understanding of the weakness of the links between economic performance and investment returns.
Whilst it isn’t possible to time the market perfectly, there is a benefit in tactical long term allocation (changing the weightings to assets) and, from time to time, tactical deallocation (not selling out of an asset class at an obvious time of stress).
(1) Cambria Quantitative Research, Where Black Swans Hide & The 10 Best Days Myth, August 2011. We have assumed that this client would be aged 67, married to a 67 year old, needing an income of £25,000 per year, after tax, which would increase in line with inflation. This income would be in addition to their other income from state and company pensions. They would pay tax at 20% on any income that was taxable. 60% of their retirement savings will be in pensions, with the remainder in ISAs. The client would stop work at age 67.
(2) “Three reasons why timing the market is so difficult”, Vanguard May 2003.
(3) Source: Vanguard calculations in USD, based on data from Refinitiv, at at 21 March 2023.
Philip Wise | email@example.com
Managing Director and Chartered Financial Planner