By MoneyMorning.com.au
‘Time in the market’ or ‘timing the market’ – which do you believe?
The answer is, it depends on whether the market is in a secular (long term) bull or secular bear phase.
If you’re not familiar with secular markets, they are long term (10-20 year) cycles that take markets from an undervalued to overvalued (bull) position back to an undervalued (bear) position. And then the cycle repeats itself.
In simple terms, the bullcharges ahead and the bearclaws back the bull’sexuberance.
Plus and minus. Night and day. Yin and yang; good and bad. Drought and flood.
Opposing forces provide balance in the world. However, the investment industry has built an unbalanced story based on the secular bull only and completely ignored the secular bear.
This investment industry bias is completely understandable. The greatest secular bull market in history treated the industry very kindly.
From 1982 to 2007 the Australian share market rose from a little over 400 points to 6,800 points – nearly 1,500% in 25 years.
The 1987 ‘crash’ and the 2000 ‘Tech Wreck’ slowed but didn’t stop the charge of the secular bull.
During this 25-year bull ride the best strategy was to hang on (time in the market), even through the tough periods. Eventually the market would take you to a new high. That was until late 2007.
The 2007 detonation of sub-prime lending killed the secular bull and awoke the secular bear. The investment industry and the majority of investors still haven’t recognised this changing of the guard.
Identifying these once in two-decade turning points in markets is critical to your investment success or failure.
The following chart (courtesy of MacroTrends.com) shows us how secular market cycles (bull and bear)have played out in the US (Dow Jones index). The returns have been adjusted for inflation:
- 1921 to 1948: blue line
- 1948 to 1982: green line
- 1982 to present: red line
In all three cycles the secular bullphase has delivered real (after inflation) returns, ranging from 300% to 700% – very impressive. Time in the market paid off handsomely.
After the secular bull finished charging in the first two cycles (blue and green lines) the secular bear set about clawing back the majority of those gains. The claw-back wasn’t a linear descent.
The market zigged and zagged its way to its eventual undervalued position (from where the next secular bullwould begin). It’s the ‘zigs and zags’ of a secular bear that requires a change of strategy to ‘timing the market’ – buy the dips and sell the recoveries.
The red line (current secular cycle) highlights this perfectly. The US secular bull ended seven years earlier than the Australian secular bull. The US market peaked with the tech boom in 2000.
From this peak it has repeated a distinctive down, up, down, up pattern. Over the past thirteen years ‘time in the market’ would have yielded you nothing in real terms. However, selling the peaks and buying the troughs (timing the market) would have been an extremely profitable investment strategy.
I readily acknowledge that without the benefit of 20/20 hindsight the timing strategy is a pretty difficult one to implement successfully.
This is why, on the surface, the industry’s message of ‘time in the market’ easily refutes the ‘timing’ option.
A lot of Pain Coming to Investors Who Ignore the Bear
However, there is a third strategy. Stay out of the market during a secular bear until valuations become cheap. History clearly shows us secular bear markets crush the optimism created during a secular bull.
Letting go of this optimism doesn’t happen overnight – human nature isn’t wired that way. It takes years to sap human confidence.
The US has played this down, up game for thirteen years. There remains an optimistic feeling the Fed will create a new secular bullmarket. While this optimism is evident then the secular bearisn’t finished – just biding its time and sharpening its claws.
The secular bearwon’t hibernate until it has ripped out investors’ hearts.
A few years ago the Wall Street Journal ran an article titled ‘The Market Timing Myth’.
The article referred to a study conducted by Javier Estrada, a finance professor at the IESE Business School at the University of Navarra in Spain:
‘[Professor Estrada] looked at nearly a century’s worth of day-to-day moves on Wall Street and 14 other stock markets around the world, from England to Japan to Australia. Yes, he found that if you missed the 10 best days you missed out on a lot of the gains. But he also found that if you managed to be out of the market on the 10 worst days, your profits went through the roof.’
The investment industry often cites the losses you would incur by missing the ten ‘best’ days in the market. However, they never mentioned how profitable it would be to miss the ten ‘worst’ days.
We know the market ‘goes up by the staircase’ and ‘down by the elevator’, so missing the down days is far more important. It’s simple maths. If a market falls 50%, it has to rise 100% for you to recover to your starting position.
Those big down days are more likely to happen during a secular bear, so for the average investor looking to retain their capital it’s best to wait for far better value to appear.
If you look at the red line on the chart above there is a massive air pocket between its current position and the two previous cycles. When this market runs out of Fed fuel and hits that air pocket, rest assured you’ll be glad you missed the big down days this secular bearhas in store for you .
Vern Gowdie+
Chairman, Gowdie Family Wealth
Special Report: UNAVOIDABLE: Australia’s First Recession in 22 Years
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