The received wisdom is that investors should not try to time their way in and out of equity markets.
When it comes to a binary choice between cash and stock markets, particularly given the positive sentiment such a protracted period of expansion creates, investors could be forgiven for feeling it is enough just to buy and hold since such a strategy has been so successful for so long.
But is it enough to say that market timing should be avoided altogether?
It is clear that the risks of being out of the market are significant. During the pre-financial crisis era, when investors could achieve a 5% return on cash savings, the opportunity cost of being out of the market with a proportion of their investments was relatively insignificant, at least in absolute terms.
Today, with cash rates below 1% and – crucially – lagging behind inflation, investors are depleting the real value of their capital all the time they remain uninvested.
There are other disadvantages. Investors who remain in cash for any length of time risk missing out on interest from bonds or dividends from shares. With the FTSE 100 yield hovering at around 4%, investors trying to time their entry and exit need to be absolutely sure they are gleaning sufficient advantage to compensate for lost potential income.
This has been particularly true in the recent period of low volatility. There have been opportunities to buy the dips in 2011, during the “Grexit” problems; and then markets continued on a relatively smooth trajectory until 2015-16 when China’s slowdown struck. In 2018, Federal Reserve tightening (February and March) and Sino-US trade relations (October and December) provided other brief opportunities. But in general, over the past decade, investors selling out at times of crisis would have found that markets seldom reacted as violently as they hoped – and they were more likely to miss out on the subsequent rise than protect their portfolios.
Market shifts are notoriously difficult to predict. An inverted yield curve has generally been seen as a predictor of recession, with a six to nine month lag. However, not only can a lot happen in the intervening six to nine months, but recession and falling markets do not always go hand in hand.
Even if the investor gets it right when they come to sell, they will have to time their reinvestment perfectly and be ready-and-waiting when the market turns.
Equally, even if you get your analysis right, the implementation may be wrong. Nowhere has this been clearer than with Brexit. Even if an investor had correctly predicted the result of the Referendum, they may not have drawn the right conclusion on the appropriate action to take. We had many clients wanting to exit the market completely in the wake of Brexit. However, to date, the right answer has been to stay invested.
All this argues against market timing. For this reason, when we receive a large lump sum from a client to invest in markets, we try to balance the disadvantages of being out of the market for any length of time, with the risks of investing just before a potential downturn. Our approach will vary on both the market conditions and the needs and wishes of the client.
However, it is not entirely accurate to say all market timing is bad. After all, we are passionate believers in active management and what is active management if not making a judgement on the right time to buy and sell? A good active manager should be able to identify where we are in the market cycle and which sectors and companies will thrive in that environment.
We also believe it is possible to add value around the core of a portfolio by allocating to peripheral markets and sectors. This too will involve judgement on the right time to buy. This is particularly true for emerging markets, which may go through long periods in or out of favour, making pricing very attractive at certain points. If we dismissed timing altogether, we wouldn’t be on the hunt for inflection points in those markets. It is also possible to actively use passive investment vehicles alongside managed funds where our analysis shows such an approach to be more effective, for example US equities where very few large-cap active managers beat the S&P500.
It may become even more important to be on the lookout for these opportunities in the environment of the next few years. As this decade-long bull market matures, investors may be less likely to make money from market beta. As such, active managers may well have a more attractive opportunity set than at any point since the financial crisis to add value through alpha generation.
Our clients expect us to do more than simply ride the highs and lows of market volatility. They expect us to use our skill and judgement to find opportunities across the globe; to decide whether Brazil or India is more attractive; whether growth will continue to outperform value – and to find the right active managers to outperform the market. This inevitably involves some decision on whether now is the right time to move.
It is not about timing the market by moving in and out, but by judiciously looking for opportunities within it.