As I’ve articulated before, I’m not a big fan of timing the market, and everything I’ve read about the efficient market hypothesis (that stocks are rationally priced at all times based on the sum of everyone’s understanding of the market) makes sense.
That being said, there also seems to be a great case against selling when markets fall, or buying when markets are very bullish (going up fast). Following the market sentiment apparently can erode the gains many investors could have made. The average investor supposedly made around 6% annually in the market during the 90’s, when the market as a whole was gaining 16% annually. The explaination for this was that most investors were following the “hot money” and buying things AFTER they’d increased in value.
The general advice (according to the article posted by Canadian Capitalist last Friday and elsewhere) seems to be that the best thing to do would be nothing.
Given this, if its a bad idea to sell after the market has dropped like it has recently, wouldn’t it make sense that now is a good time to buy? If people lose money selling in fear after a drop and buying in greed during a bull market, it seems to me that doing the opposite should be a good idea. This is often called a contrarian strategy and while I haven’t read much of an objective critique of it, I imagine the investors I admire would claim that its just another form of market timing.
My strategy is to buy from a pool of stocks that have a long history of uninterupted, increasing dividend payments. I currently own BMO, NA, ROC and RUS (this one was a mistake, I somehow got it in my head that it fit my criteria, and afterwards realized its a cyclical). After a price drop, it seems rationale to try to scape together more money to buy more of this (since if I figured they were worth buying at X, they should definitely be worth 90% of X).
I believe the conventional wisdom though, would be to just keep buying on my regular schedule and not try to buy extra (i.e. time the market).
Can anyone point me towards an explaination why I shouldn’t do what I’m doing?
August 21, 2007 at 10:55 am
I believe the market is not 100% efficient. I also believe that individual stocks within the market can be successfully ‘timed’.
The reason is that stocks don’t trade based on fundamentals in the short term, they trade based on emotion, expectation, greed, and fall victim to forces such as haste, panic, and following the herd. As long as the market depends on people for it’s movements, it will never be 100% efficient and thus it can be timed. What works as far as strategies people use to time it, is a whole other conversation.
August 21, 2007 at 11:11 am
MG: You’d think though that people (like us) would take advantage of these inefficiencies, and thereby remove them. If enough people start loading up on stock “because there’s a sale on”, the sale will end…
August 21, 2007 at 11:44 am
I’m not sure if “buying on dips” is the same as market timing.
I think market timing when done properly means having a set criteria for entering and exiting the market. These switches could be done several times a day/month/decade whatever…the point is that you are going in or out of the market for a logical reason (and not greed or fear). I don’t believe this works but to each his own I suppose.
I think that waiting to get a better deal on a stock is technically a form of market timing but I don’t see anything wrong with it assuming that the stocks you are interested in have volatility and you are not in a hurry to invest. BMO for example was selling for $72 recently and $60 even more recently. Of course it could have been selling for $80 instead of $60 and then you’d be kicking yourself for not buying at $72. Ok maybe it’s exactly the same as market timing
On another note – did you buy anything in the last week? I thought briefly about it but didn’t.
Mike
August 21, 2007 at 11:55 am
In my belief anytime you decide a certain time is ‘good’ to buy a stock then you are timing it, whether it’s ‘buying on dips’ or not.
The reason there is opportunities is because there are always more people on one side of a trade. The sale is created by the masses…
August 21, 2007 at 12:05 pm
4P & MG: I think I’m with MG on this, although I’d agree with you Mike that there are different forms of market timing (and the who soothsayer, mystical technical trading appraoch seems very silly to me).
I had the strategy that I’d buy stock, and try to keep my margin account for taking advantage of “buying opportunities”, which I’ve been doing throughout the recent volatility. I’ll write up a post soon detailing all of the specifics (basically I just extended my position and pushed into a new bank, NA).
August 21, 2007 at 12:36 pm
One other thing I forgot to mention – Bernstein himself says that the best time to buy is “when things look their worst” and vice versa. He is completely into the efficient market theory but psychology is a big part of his approach.
MG – good point but “opportunities” don’t always work out.
Mike
August 21, 2007 at 12:46 pm
Mike: Excellent point, that’s what confuses me on this issue, people I really respect (like Bernstein) prove the EMT, then basically suggest a course of action that seems to rely on it being false.
Perhaps its a weak vs. strong version of the theory and the the EMT is true over the long term but not the short term (and volatility therefore gives you opportunities to exploit the inefficiencies, perhaps that’s the “payment” we receive for keeping the market efficient).
August 21, 2007 at 1:07 pm
I’m a believer in Long Term = Efficient / Short -Term = Not Efficient
Mike – It depends what you mean by ‘work out’, it’s always a bit of an educated bet, that’s what makes it an investment…
For example if I buy a company on a 15% share price dip, that increases it’s dividend every year (like Bank of Nova Scotia) – what is my risk vs. reward for this action?
Personally I think things get tilted far to the reward side when you consider I am buying the company cheap relative to projected earnings growth and P/E, and they have raised their dividend (which currently yields 3.8%) every year for many years. I will be a holder of this stock for over 15 years. My worst case scenario does not seem that likely.
Bank of Nova Scotia cuts their dividend, becoming the first Canadian bank to do so in the last 20 years that I know of, their share price plummets. They then go bankrupt, as they lose share value and cut their dividend repeatedly over one or two years.
In probably 90% of scenario’s other than the above, I will make money long term, and by money I mean average 3.5% dividend + > 4% growth so at least 7.5% compounded annually.
August 21, 2007 at 1:11 pm
Hard to say. There does seem to be a conflict between the EMH and the “buy at the darkest hour” advice from Bernstein.
On the other hand, whether it’s part of EMH or not, Bernstein talks a lot about market bubbles and crashes and says they will be inevitable and if you can recognize them, then you can limit your losses and/or increase your gains. Trying to do this is definitely market timing which is why in the end he basically says to stay invested in equities throughout – use regular contributions to accumulate your portfolio. If you are retired and the market goes down, then don’t sell anymore than you normally would (don’t panic) and if you are accumulating and the market goes up then don’t buy any more than you normally contribute (greed) and of course don’t sell because of fear.
Long story short – figure out an investment plan you can follow and stick to it!
Mike
August 21, 2007 at 1:23 pm
Well, my plan (with respect to stocks) has been to buy long-term, stable companies with consistent increasing dividends. I try to tweak this by targetting dividend-yield (which I realize some feel is a short-sighted move if you aren’t factoring in dividend growth).
Obviously if you’re chasing yield, corrections like this turn into a real buying opportunity (so I *hope* my behaviour has been consistent with my investment plan
).
August 21, 2007 at 1:26 pm
Agreed. Stick to a strategy….but some are easy to judge than others…for example:
Darkest hour = No one knows when this is.
Most Exuberant hour = No one knows when this is.
Quality, dividend growing stock drops by 15% for a reason that is not directly related to poor earnings performance. This is reasonably easy to detect. Certainly a ‘dark hour’ for the stock. In fact I would rather buy it at this ‘dark hour’ than when the stock has dropped due to poor earnings or other company specific reasons. Could the ‘hour’ get darker, maybe but at least you know you bought a quality stock when the shares were down for reasons other than poor earnings performance.
August 21, 2007 at 1:39 pm
MG: I wonder if there’d be some easy way to compare similar stocks to determine this, e.g. look at a CND bank stock share price drop compared to the other banks, if they’ve all dropped, its a “dark hour” situation, if its dropped independantly, then its a “problems with the company” issue. The same could be done for measuring exuberance.
August 21, 2007 at 1:40 pm
MG – I can’t disagree with what you say. Your point about the long term investing is especially good – as long as you pick even moderately good stocks then time will certainly be on your side.
August 21, 2007 at 1:50 pm
It always comes back to earnings growth, and long-term investing.
August 21, 2007 at 1:53 pm
We should be having this conversation over a pitcher of beer
When are you going to come down to the big bad city MG? 
August 21, 2007 at 2:16 pm
We really should….
I’ll let you know ahead of time…
August 22, 2007 at 6:08 pm
Hey I’m late to the party!
But I don’t really believe in the “Efficient Market Hypothesis”. My step-father probably put it best: “The markets are the collective well of emotions of human investors”.
Efficient Market assumes that everything is known, but I don’t believe that it is, b/c people are always prospecting. When I buy a non-dividend stock at X I am inherently stating that I believe that stock is actually worth more and that I will be proven right.
“Timing the markets” has received a bum rap but it also has a very shaky definition so it’s not really fair. I mean, what exactly is “timing the market”. If I buy a stock today and then it doubles tomorrow and I sell it, was that “market timing”? What if it was next week? next month? next year? next decade?
Look, at some point you are “timing the markets”. When you buy a house, or lock-in an interest rate or even negotiating salary on a new job you are timing. You’re making some financial decision based on the information at hand. When you drop money into the fund every two weeks, you’re inverse-timing (which is still “timing”), you’re basically saying that you figure the markets are up long-term and that regular deposits are the best way to manage the small jumps. But at some point you’ll take that money and put it into Bonds, how are you going to make that jump without “timing the markets”?
And that’s OK, that’s how you get ahead. You get ahead by making better decisions than the competition. The markets are a zero-sum game, just like say poker. Good poker players take risks, but they pick their spots. When you’re playing the money game you have to do the same thing.
B/c the game is zero-sum you cannot make money doing “what everyone else does”, that’s the contrarian in you speaking up. If you want to “beat the markets” and “do better than others” you must inherently do things that others are not doing. You have to make money by taking it from other people, so at some point you must do things that others are not.
So if you have 20k in an account somewhere it’s perfectly OK to place positions to try and make some extra short-term bucks, that’s the name of the game.
August 22, 2007 at 6:20 pm
Gates: I agree with some of your points, however the whole “wisdom of crowds” idea seems to push towards an efficent market (especially when money, which people care very much about, is placed on the line and can be used to indicate the “strength of your feeling”).
Lots of people feel, as you do, that they can price the market better then the crowds, but supposedly (I haven’t read the research papers, so this is second hand) when you put them in charge of a decent sized mutual fund they revert to index return – fees + random volatility.
How would determine a price that is more accurate then the market as a whole? How do you know you’re giving any piece of information the right “weight” for the price? If its publicly available info, how do you know it isn’t already built into the current share price?
August 22, 2007 at 7:02 pm
Gates,
Good post, I agree with most of your points.
August 22, 2007 at 9:03 pm
[...] you enjoyed this post then you will probably enjoy Financial Security Quest’s post a couple of days ago pertaining to market timing. There is a good discussion with that post as [...]
August 22, 2007 at 11:43 pm
Gates – good points.
One thing though – if you believe that you can beat the market then why don’t you put all your money into that effort? Obviously if you want to be diversified then it’s hard to pick stocks worldwide but maybe all your Canadian content could be hand-picked stocks?
Mike