“It is About Time in the Market, Not Market Timing!” — this is a quote that is repeated over and over in the media and blogosphere by anyone and everyone, until those words completely lose their meaning and simply become something that is repeated as a mantra. While I agree with the overall premise of the argument, the concept is a bit more nuanced and needs addressing. In one way or another, market timing has to play a role in each investor’s moves else you might as well just set your cash on fire and watch the flames.
What is Market Timing
Over the course of last few months, as I have resorted to selling more of my broad equities, I have received a lot of emails and comments calling me out that I am trying to time the market and making “one of the biggest mistakes of my life”. Really? Biggest mistake of life? How exactly? How is going to cash and not participating in this stock market charade the biggest mistake of my life? It is not just me…I see similar comments on other blogs when they sell their equities and move to safer investments or cash.
Market timing for most people seem to equate with trading in and out of securities on a daily or weekly basis. While there are traders who can make a living doing this, I am not smart enough to figure this out and will go as far as to say that its extremely difficult to make money when you compete with the big institutions who have far better resources at hand. But as the time horizon increases — medium and long term investments (again, this is subjective — but for me, medium term is 1-5 yrs and long term is 5+ years) provide more unknowns and no one knows how things progress. This added uncertainty levels the playing field in a way by bringing in more randomness to the world.
Sticking your head in sand is not a strategy!
I will not name some of the folks I have beef with, but I have heard some unbelievable comments and tweets. I routinely see something along the following lines:
“Dont worry about the valuation. Ignore what the stock price is and always buy blue chip stocks that pay dividends”
WTF?! Im sorry…If you so badly want to give me your money, I will happily take it and sell you my overpriced stock. Better yet, just transfer your cash directly to me and lets cut the middleman/broker out.
If there is one single most important thing in business and investing, it is…valuation. You always, absolutely have to pay attention to valuation. Ignoring valuation and blindly buying any asset at any price is a recipe for disaster.
Valuations are a cornerstone of business and investing and I will talk more about it later. If you are willing to risk majority of your capital to make 1, 2 or 3% in dividends for a stock that is ridiculously overvalued, you are going to get slaughtered! Those first few years of dividends don’t even matter if you are overpaying for a stock negating the returns that you perceive. Remember that common shareholder’s dividend payout come way down on the totem pole. During a recession/liquidity crunch/financial crisis, there will be a long list of creditors who will be paid well before the board of directors of a company even consider paying common stockholders. 2008/2009 was not that long ago and yet most investors seem to have forgotten the lessons.
Its Not Just Selling…Buying Counts as Market Timing Too
Don’t forget that the act of buying is also market timing. You are essentially entering into a position with confidence that the stock price will rise and meanwhile may or may not earn income via dividends during the holding period. Unless you subscribe to a more passive investing approach of dollar-cast averaging broad index funds (although an argument can be made that this is market timing too), buyers are as much of market timers as sellers!
Market timing should really mean that you are confident enough to put your capital at risk in order to make money. This means that the risks are substantially lower and the rewards far outweigh the risks. The latter portion is extremely important and investors should not lose focus on that point. Why bother investing and putting your capital at risk if there is a high likelihood of losing most of your capital. The understanding of the risk-reward situation is limited in most retail investors due to lack of self-awareness and other psychological issues. Market psychology plays a much bigger role than most retail investors care to admit. Market timing does not necessarily mean trying to call the exact bottom and exact top. One quote that stands out from FI Fighter (paraphrasing) that hits the nail on the head:
“Forget about trying to capture the top 10% and the bottom 10%. You will never time it perfectly….but the remaining 80% is accessible when you want to ride the bull market”
Thats enough abstract talk…lets put it in plain words with the real world.
The stock market today is hovering around all-time highs. Back in 2009/2010, when the bull market started, we saw rampant (1) earnings growth which saw great returns for a few years. Putting money into the stock market in 2009/2010 was almost a no-brainer — it was pretty clear that recession was behind us (originally high-risk due to some unknowns but subsequently subsided to low-risk-high-reward scenario) and companies were finally starting to grow again. After that came (2) multiple expansion, where stock prices saw continued growth and investors enjoyed prosperity. Multiple expansions have played a huge role in most bull markets (including the current one) and usually lasts a few years. Next comes (3) earnings contraction, which we’ve been noticing for the last year or so. Most companies have seen falling earnings even after considering the immense stock buybacks to buoy the EPS numbers. Not only that, but companies have discarded the GAAP measures and coming up with unique financial metrics to massage the numbers. Dig a little deeper and you realize that the GAAP earnings are far worse than already suggested by the “earnings recession” (the media likes to portray it as something localized and doesn’t have wider consequences). This is where are currently in the cycle, which is a high-risk-low-reward situation. But yet, stocks continue to hover near the all-time highs.
What could happen going forward? One of two things. Either we see a (4) multiple contraction (commonly known as ‘market crash’) — a natural and healthy part of the economic cycle; or companies will magically start growing their earnings justifying the high stock valuation. I dont know about you, but my money is on the former and not the latter.
Do I know when this will happen? No. Just like you, I do not know what the future holds and when the markets will crash. If I did, I would short the market perfectly. But be assured that the markets will crash — everything is cyclical. And on that front, I have read comments from some saying: “What if the stock market never crashes and will keep going higher and higher”. Lol….Famous last words! 🙂
Market Timing in the Business World
Think about the businesses you are a shareholder in. The smart businesses are good market timers. They are ahead of the curve and make a product or service that will create enough demand to fuel the company’s lifecycle. They pick up assets when they are underappreciated and hated by the rest of the world. If the same mentality applied as some retail investors who say not to pay attention to valuation and just buy at whatever price, those businesses would not exist in a few years and would be driven into the ground.
You have to look no further than companies like Berkshire Hathaway (BRK.A, BRK.B). Companies like Berkshire always build up a huge reserve of cash in the late stages of bull market. The current reserve stands at a whopping $65B. Why isn’t BRK putting money to work? Why isn’t it depleting its last penny and putting it in the stock market where it can earn more than $2-3B in dividends? (Surely, they’ve heard of how amazing everything is in the financial world these days :p ) Again history provides a lesson here. BRK uses its massive hoard of cash strategically during recessions, liquidity crunches and/or financial crises. During the 2008/2009 crisis, BRK was getting sweetheart private deals picking up massive assets for pennies that were not available to the general public. In similar events, you and I as retail investors will never get that sort of a deal but there’s still a lesson to be learned. Build you cash reserve BEFORE the crisis and wait for those fat pitches.
Another example is Franco Nevada Corp (FNV). For those unaware of this company, it is a streaming and royalty focused company in the precious metals space. It has the best assets in the gold and silver space (they have other exposures too – such as oil & gas). Have a look at the video below and pay close attention on the strategy they take. During the gold bear market of 2011-2015, they were buying underappreciated assets left, right and center. Now that gold and silver have entered a bull market and the junior miners can raise money easily, they have started looking elsewhere for underappreciated assets. The company is so strong financially and holds such fantastic assets, that they literally have to do nothing for the next 30 years to reap the rewards of their deals. Now that is some lucrative deal-making! FNV is not chasing after higher multiple companies ignoring the valuation — which is the point I try to make with this post.
The deal-making of FNV is so good that the stock’s steady appreciation speaks for itself. Note that gold and precious metals just went through a bear market from 2011 to 2015. For what its worth, the company is also a dividend payer and grower making it an ideal foray for DGIs into the gold space.
But why invest in gold? As one (ex-?) reader commented in the past on this blog:“Gold is a garbage investment”, which truly was spoken from a standpoint of ignorance. I will leave that for another day as it needs a long separate post 🙂