Back in late February (which now feels like a lifetime ago), a colleague and I were chatting about the stock market.
The S&P had just gone down through the 3,000 mark. The said colleague, who happens to be a very thoughtful person, mentioned that he was worried about the prospects of a pandemic and had therefore cashed out his entire equities portfolio of roughly $1m.
“Things will get worse before they get better.”
Boy, was he right or what?
Within the next three weeks, the S&P 500 had collapsed by another 25%. It would probably keep on plummeting had the Fed not intervened on that fateful Sunday night, finally injecting a dose of stability by promising to flood the markets with liquidity.
Fast forward another 3 weeks. Mid-April, the S&P was back up to ~2,850. The same colleague and I were preparing for a client call (this time, on Zoom) when he said:
“I feel like I missed my chance to get back in.”
He ended up sitting on cash for another few weeks, by which point the S&P had blown back up and through the 3,000 level. Then he finally accepted the situation and put his cash back to work.
A Numbers Game
There is no schadenfreude in this story. I like and respect the guy. He isn’t a show-off and he never gloated about making the right call just before the market began its frightful descent.
Instead, I reflect on this story as the perfect encapsulation of just how hard it is to time the market.
History tells us that between 1946 and 2018, the S&P had gone down by 10% or more on 26 separate occasions.
Courtesy of CNBC
In addition, there have been 12 bear markets in that time period.
Courtesy of CNBC
In total, 36 declines of 10% or more. On average, that’s once every two years.
Sometimes, there may be some indication a meltdown is coming. In retrospect, the exponential rise in the number of Covid cases had given us a proper heads-up.
But many other times, there is no rhyme, reason, or warning, and the market simply corrects out of the blue.
The problem is that simply having the supernatural prescience that allows you to anticipate market corrections five times a decade doesn’t mean you’ll be able to profit from them.
The additional challenge with market timing is that you’ve got to be right twice: when you initially cash out AND when you subsequently get back in.
I’ll leave it to you to decide whether you can consistently make the right call every single time.
To me, it’s the equivalent of a running hot streak at the roulette wheel. It involves zero skill, there’s a minuscule probability of it happening, and at some point, it’s bound to end.
The other problem is that significant up and down days in the stock market occur in close proximity to each other. If you happen to be off by a day or two, this is what ends up happening to your returns:
The Other Side Of The Story
While my colleague was sitting out the meltdown, another equally fascinating story was playing out in the UK corner of the personal finance blogosphere.
Fire V London, having just sold his house, had £1m of cash to put to work. And off he went, a spectacular example of holding one’s nerve while there was more than a trickle of blood spilling onto the streets.
When times are good, it’s easy to convince yourself that you’ll be ready to pull the trigger and take advantage of buying opportunities like the Covid pandemic.
Not so much when everything is going haywire.
Now, I would never advocate buying single stocks, but that’s beside the point. Because a full six months and a complete market recovery later, I still find Fire V London’s behaviour highly impressive.
It’s one thing not to sell in a downturn (tick).
It’s another to keep buying – when the buying happens automatically, as it does in our workplace pension plans (tick).
But it’s a totally different level to proactively go in and put extra money to work when the world is collapsing, and everyone is urging you to run for the hills while you still have a chance.
As Napoleon once said:
“A genius is the man who can do the average thing when everyone else around him is losing his mind.”
If Mr. Market caught you flat-footed back in March, don’t despair. More likely than not, another opportunity will present itself over the coming months.
The first market wobble came when it transpired that the vicious market “melt-up” may actually have been caused by Softbank buying up billions of call options on tech stocks.
Just a few weeks later, it seems to be wobbling again. There are many reasons for it.
The proverbial winter is coming. A vaccine is still some time off. Second lockdowns loom large across the world.
There is absolutely no doubt we will get out of the woods at some point – but we are still far from it.
In the meantime, we all know how this story will play out. Should the market lose another couple hundred points (as it always does on its relentless march upwards), panic will set in yet again.
Most investors will rush for the exits, crystallizing losses along the way. Along the way, they will shout at everyone who will listen:
I TOLD YOU SO!
“I told you the market was disconnected from the economic reality!”
“It simply couldn’t last!”
“The house of cards is finally coming down!”
Sadly, a few months later those same investors will lament the opportunities missed, alongside everyone who heeded their advice.
If at this point in time timing the market still looks appealing to you, let me give you something else to noodle on.
Here is an excellent writeup from Personal Finance Club on why market timing is a suboptimal strategy.
You should really take the time to read it, but the TL;DR summary of it is that a steady contribution strategy actually beats the ability to call the market.
It goes against what most people do during market corrections.
Let’s admit it – it’s also uncomfortable scary as hell.
And yet, it works.
At the end of the day, successful stock market investing requires very little skill.
You don’t need a PhD in finance, an expensive financial adviser, or a powerful computer sitting right next to the exchanges.
All you need is the ability to hold your nerve. If you haven’t got it, start working on it now. It may come in handy sooner than you think.
About Banker On Fire
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Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.
Find out more about me and this blog here.
If you are new to investing, here is a good place to start.
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