Timing the Market, or Time in the Market?
Professional money managers tend to look at statistics and averages to determine how expensive or cheap the market is relative to certain periods of time. We also look at economic growth and corporate profits to determine whether growth is likely to expand or contract. This helps us to better understand where we are in the business and credit cycles.
While these tools can be instructive and can help serve as reminders to not add too much risk during periods of ebullience, or to get too conservative during periods of despair, they were never meant to be used as “timing” mechanisms so people could sell at market highs or buy at market lows.
That’s because things like valuations, for example, can stay very high or very low for an extended, irrational period of time.
While some of these tools can help with tactical positioning or risk management ranges, such as what to over-or under-weight in shorter time frames, they were never meant to be a strategic or long-term forecast of how the market will perform many years in the future. Hypothetically speaking, it’s possible for valuations to come down, not because of prices falling, but because of accelerating earnings growth. It’s also possible for valuations to increase simply because earnings growth is decelerating. (Prices typically do move with earnings, however.)
There have been numerous studies looking at missing the best or worst days of a market cycle and how that affects both short and long-term performance (returns). We’ve decided to do something a little different this time. We looked at thousands of long-time horizons of staying fully invested to learn what were the very best and worst-case scenarios. We looked at US stocks going back to 1928. We used trailing 10-year periods and assumed the reinvestment of dividends. We found that looking at more frequent intervals, such as year-to-year, or excluding reinvested dividends, increases market noise. By looking at 10-year rolling periods that also include some extreme daily moves, we were able to identify up and down trends as well as periods of volatile or inconsistent return patterns. (We don’t have nearly as much data to look at bonds, as measured by the Bloomberg Barclays US Aggregate Bond, but this data is still instructive.)
We can learn a lot from examining this data as shown in Exhibit 1.
Exhibit 1 – U.S. Stocks and Bonds
Below are some findings:
- Markets have been positive in each 10-year period 94% of the time. Waiting for very long periods of time to get invested can be a large opportunity cost.
- 53% of the time, markets have annualized between 10% and 22% for 10 years
- 84% of the time, markets have annualized more than 5% for 10 years.
- Only in 5 years (2008-2010 and 1938-1941) out of 80 were trailing 10-year returns negative. (These were related to the Great Depression and the Financial Crisis, respectively, of which similar events are not likely to occur with high frequency.)
- The market went on a 16-year streak of 10% or more, 10-year annualized returns, in 1950, and a 19-year streak in 1983.
- Based on the data, the very worst time to invest was after the market had a 10-year annualized performance of 20% or more. This happened in 1959 and again in 2000. (In the 2000s, we suffered from not one, but two recessions in the same decade.)
- The very best times to invest were when the markets returned 0%, or negative annualized returns, for the prior 10 years. (1939, 1974, and 2009 were excellent years to invest.)
- When markets had 10-year annualized returns between 5% and 10%, it’s inconclusive as to whether the forward returns were better or worse. (There were some periods where future 10-year returns were better and some where future returns were worse.)
- The current trend for 10-year annualized returns is still positive, meaning that it’s possible for the market to move much higher still. Of course, there would likely need to be some economic basis for this to happen.
- Bond market returns (black line) have gotten lower and lower on a 10-year annualized basis and currently are at their lowest. (Which is not to say these returns can’t go lower still.)
Not surprisingly, one of the big takeaways from this data is that investors are better off staying the course and sticking with their objectives. Trying to “time” when to get in and out of the market is extremely difficult and can only be accurately and consistently done with perfect hindsight, which nobody has. If the market is at very extreme levels, where 10-year annualized returns are zero (or negative), or if returns are close to 20% or more, these are areas where investors might find some opportunities to gradually and tactically increase or decrease their risk exposures. Keep in mind, though, that stocks are on the inside of these extreme levels roughly 90% of the time. The challenge also is that the very best time to be invested often feels like the darkest and riskiest time to invest, and the worst time to invest (or best time to take some profits off the table) is when everyone appears to be making lots of money and there is a great fear of missing additional upside.
Be extremely cautious whenever you hear the words “this time it’s different.”
Looking at this data alone, the markets could move either higher or lower from here. Being properly positioned with the right risk profile and diversification, however, will help smooth out periods of high volatility, which, as we have seen the last few years, can greatly ebb and flow.