Today, November 30, 2011, the market was up 4.3%
I’m glad I was in the market today
You’ve probably heard the advice that market timing is a bad idea because if you exit the market you’ll miss the dramatic up days (like today). Many, well respected investment advisors tell us that market timing is a bad idea. Here’s an article at CBS News from December 2009 advising against market timing:
The road to investment hell is paved with market-timing efforts because so much of the long-term returns provided by the market come in short and unpredictable bursts. For example, one study, covering 107 years ending in 2006, found that the best 100 days (out of more than 29,000) accounted for virtually all (99.7 percent) of returns.
But wait!
This article in Forbes tells us:
Proof of the fallacy of buy-and-hold as a strategy is easy enough to find. In the 1929 crash and its aftermath the market lost 86% of its value and did not get back to its 1929 level until 1955, twenty-six years later. That was 26 years of waiting for buy and hold investors (if there still were any) for the market to ‘come back’.
Here’s another article making the same point.
Who’s right?
There’s really two different issues here that should be treated separately. First, yes, blind buy and hold is dumb. You need to actively manage the equities you hold. Market cycles move more quickly now, especially if you’re investing in tech stocks or commodities like gold or oil.
But timing the market is impossible, especially the whole market. My view is that timing the entire market is tough because it is driven by truly unknown factors such as 9/11, bank failures, secret negotiations between Germany, France and Greece, and so on.
What is one to do?
The first thing to observe is that it really is possible to separate good companies from bad. Buy good companies (of course). But that’s not the complete answer. Even if you held the 20 best components of the S&P 500 in 2009 you would have lost 40% in the down turn.
The rest of the answer is that you’ve got to have hedged positions too. That doesn’t necessarily mean you have to short stocks, but you do need to consider equities that zig when the rest of your portfolio zags. Gold, oil, bearish funds and short ETFs can accomplish this. The trick is to find the right mix.
I’ll say more about that in coming posts.
Disclosure: Tucker Balch was up too late.
the augmented trader 
J.R. Charlton
August 19, 2012
I think buy and hold is the only strategy. Essentially, this is what I see. The first thing I notice is that so many analysts are focused on predicting the future; whether they are seeking to forecast earnings, or whether they are intent on valuing an enterprise, or whether they are seeking to decipher how much value at risk is being incurred, pretty much everything I see in finance is focused primarily on forecasting the future.
The second thing that occurs to me is the lack of any utility in forecasting the future (of anything). What good can come of that? If we are a part of the system which we are forecasting, that is, if our forecast has any impact on investment or business decisions, then in predicting the future with any certainty ensures that our forecasts will impact the future and thus render our prior assessment incorrect (so what’s the point?). On the other hand, if we are external from the system which we are forecasting (if that’s even possible), then even were we able to predict the future with certainty, we certainly could do nothing about it, not even prepare for it. There is no edge to be gained from forecasting. All this effort seems to do is help us construct a mental picture, a set of expectations, that helps us sleep comfortably in the assumption that our hard work has resulted in eventuality of those expectations. Nevertheless, there’s absolutely no reason to assume that our forecasts will be correct or even close to correct. How many forecasts were made for any US traded equity for September 11, 2001? And alas, how many prices of shares were there on that day?
So the third thing that I notice is where that leaves us. Pretty much, all we have left is the probability that a stock will even post a return at all in the futures we construct, much less the magnitude of the return or loss. And what can we surmise from that? Take your everyday. You wake up. You maybe eat breakfast, drive to work, hoping to make it on time, and by the time you get there, you pretty much have a good idea of how you think the day will go. You have a forecast of it. For as much as you see being accomplished in your day, the amount you accomplish is pretty standard. Of course, you have your exceptional days, but not even Einstein wrote papers equivalent of his relative mass equation every single day. He had his exceptional days, but pretty much he went to work moving at the same pace every day. And perhaps we have even longer plans for the immediate and long term future. Both those are even more shifty than our daily plans before we arrive at work (which is a lot different from the bond-yield curve). While our objectives in the long term maybe seem within a fairly stationary range, everyday the means by which we hope to achieve those objectives shifts like sand dunes on the border of Saudi Arabia and Yemen, and if we’re honest with ourselves, we realize that while everything is constantly changing so that there’s a lot of change occurring, everything isn’t changing that much. Everything kind of shifts a little here and a little there so that while the picture is certainly different, there’s nothing striking about it, especially if we look at that 4-dimensional picture over a long period of time. The future and the past look strikingly similar, especially when tomorrow becomes yesterday and is compared with the day before yesterday. And therein lies the reason why buy and hold is a great strategy.
Just about every market, the NASDAQ, the S&P 500, the Russell 2000, etc., they all have a cumulative probability of daily return of 55%. Look at them all over any period of long period of time, and you pretty much come to this conclusion. Even in the down times, the market goes up and down, and what’s interesting is the way in which they do this. They just go up one day, and the next day they go down, and this back and forth (with just ever so much more forth than back) goes on and on, into every future. On a daily basis, you never really see a lot of days in a row where the market just goes up followed by a lot of days where the market just goes down. It’s like the ebb and flow of the Pensacola tides. And while this 55% seems to be a probability that approaches the chaos of 50/50, there’s an order to it, just like those tides. It’s like a metronome. Now as we increase the window of our perspective out to annual returns, kind of like our plans of where we think we’ll be in a year, the probability of all those markets providing an annual return approaches 75%, but our ebb and our flow aren’t as much like clockwork anymore. Even though the probability of us generating a return is higher annually than on a daily basis, the seas are rougher. Annual returns occur again and again, day over day, but when annual losses occur, they occur day over day. While the clustering of the swells seem to happen, the order of their periodicity seems to break down to chaos. And that’s just the story for annual returns. The increase in the probability of a return just increases with the interval of a return, albeit at an ever slower rate, relative to the clustering of the chaotic swells we have to deal with. And that’s a lot like our experience. The further out you look into the future, the further the lattice work of possibilities and the times for those possibilities spreads. When we look further back into our past, the further we go, the more chaotic it gets in terms of trying to put a coherently static picture together. But if you just compare today to yesterday or tomorrow to today, there’s just not that much of a swing; it takes a long time for a tide to erode the beach, just like it takes a long time for stock to climb higher in the zero sum game.
When we purchase something or don’t purchase something, we speculate on our future and how much of that future exists for us and the purchase (for instance, you don’t see 150 year bonds; sure they have value, but to whom?). When you construct a probability, you just recalling how many times the future you are constructing has already happened in the past. And when you are planning your day, just like your portfolio, your assessment of the future is the future that is most likely, the future which has already happened so many times in the past. The probabilities I cite are pretty spot on, and the means don’t really deviate. On a daily basis, the order doesn’t even deviate. Of course it’s going back and forth, but that’s pretty constant. And if you just purchased the market every single day, or had you for the past 20 years, you’d have gotten about a 900% return on investment (assuming no fees of course). Now of course, I’m not assuming the risk-free rate, but even if you factor in the risk-free rate, the probability that the market provides a daily return in excess of it is still about the same. And it’s simple to see why this is better than any other strategy. One, no matter how awful financial times we’ve seen, while there are stocks in the market that fail and go bust, the market doesn’t go bust. We still have a NASDAQ. We still have the NYSE. We still have the Russell 2000, and we still have the S&P. They don’t go anywhere. They just survive, and they should on a daily basis. They have a 55% chance of survival which is just high enough to not be considered a statistical aberration within a margin of error.
Now, there’s no such thing as timing, because there’s no certainty that the future upon which you made your investment decision is ever going to occur – the likelihood of something occurring becomes generally independent from the likelihood of when it will occur the further you look out. However, there is a way to see if you’re getting a good price for your decisions. That is, is it a good time to buy the market (are you getting it cheap) or when it’s a good time to buy bonds? And the way to do that is to see how returns are scaled to probabilities. Do we have a preference for risk-minimization, or are we risk loving? If we are risk-fearing and prefer security, then we should see a logical relationship between the scale of market returns and the probability of the market providing a return. In that case, we’re getting stocks on the cheap and we should sell our bonds and buy those stocks. If we are risk-loving, we should see a more chaotic scaling of returns to probability of returns. In that case, we should buy bonds and hold them because they’re a good deal.
For the past three years, we’ve been risk-fearing, and stocks have been a good deal. Bonds have been getting relatively more expensive. There is a clear relationship between the probability of every single stock in a market providing a return and the scale of their returns. That relationship has been ever tightening to be a clear relationship. But it has been slowing. It may still be a good deal to buy and hold stocks for a little longer. But the risk-fearing relationship I’ve observed can’t get too much tighter than what I’ve observed. I think the trend will soon be going the other way, like when you walk on the beach, trying to guess where the the wave will stop before it starts ebbing back out. You watch how the rate at which it arrives at your feet slows down to a point where it stops and then slowly ebbs back and starts building up speed before it sinks back to feed the next wave.
Given the unlikelihood of any future at a distance, buy and hold may be the only viable strategy that exists. In such a strategy, the question is am I getting stocks cheap or am I getting bonds cheap. I think for a while it’s been stocks that you’re getting cheap, and it’s slowly finishing that trend. Soon you will be paying a lot more for them, so when that time comes, I suggest you sell your stocks, and buy the bonds – they should be getting cheaper soon.