Timing

 By Guest Blogger Doug Rowat

Warren Buffett once famously said that he “made more money when snoring than when active.” Buffett, of course, is well aware that most investors are terrible at predicting short-term market swings and that the best plan is to simply be boring and stay invested. Yet we mostly can’t help ourselves. As proof, the comment section of this blog will shortly be filled with individuals making short-term market predictions with many suggesting that the market is rigged, the economy doomed and that hiding in cash is the best option.

However, JP Morgan research clearly shows the difficulty of trying to time markets. Staying fully invested in the S&P 500 from 1994 to 2014 would’ve generated a 9.9% annualized return, but missing just 10 of the best trading days would have dropped the return to only 6.1%. Ten days over 20 years. Don’t tell me that you would have known when those 10 days would have occurred?

But note that, historically, the best days tend to arrive fairly near to the worst days. However, what’s the most likely scenario? The worst days would likely prompt a retail investor to move to cash with an almost zero likelihood that they would then shortly after re-enter the market in time for the strongest market days. What my nearly two decades in the investment industry has taught me is that once a defensive cash position is taken, it’s a position that remains, often for years.

Performance of US$10,000 over 20 Years: Missing Just a Few Days Cripples Performance

Source: Business Insider. JP Morgan Asset Management. Data as of Dec. 1, 2014. Measures return of S&P 500.

A favourite pastime of Canadian investors is also attempting to market time the loonie. We simply love doing this. It’s as Canadian as Tim Hortons’ coffee. However, market timing currencies is even worse than timing equities. This is because equity markets are much more forgiving—over time, they move higher. Not so with our Canadian dollar/US dollar exchange rate. Our loonie, for instance, currently sits at roughly the same level that it was at 30 years ago! Currencies tend to move in giant M or W patterns and timing each peak and valley is exceedingly difficult. An article in the Wall Street Journal a few years ago highlighted some of these issues:

Only about 30% of all retail forex trades are profitable, according to Aite Group [an independent financial market researcher], largely because of traders’ lack of education and experience in dealing with a market dominated by institutions.

Eventually, as you attempt to repeatedly time all the tops and bottoms, you’ll be wrong, and the incorrect timing could create permanent losses. With equity markets, an incorrect entry point will, of course, cost you time, but it’s very likely that, if you’re patient, you’ll eventually profit, most often within a year or two. But with a poorly timed currency trade, you could easily go a decade or more in a loss position. For instance, if you’d bought US dollars in 2002 when the Canadian dollar was at about 62 cents, you’d still be waiting for your ‘trade’ to be in-the-money.

In Roughly 30 years, CAD/USD FX Rate has Gone Nowhere…

…While the Canadians Equity Market has Advanced almost 600%.

Source: Bloomberg, S&P/TSX Composite return includes dividends

Forecasting the loonie is a fun pastime, but the best strategy is simply to convert currency on a consistent and routine basis, perhaps quarterly, to hedge risk.

Another timing-related question we get asked constantly: what percentage will XYZ market go up this year? Blunt answer: I have no idea. According to Vanguard, 13.7 percentage points was the average annual forecast error among leading market strategists from 1998 to 2016. In fact, if strategists had just given the historical average return for the market they would have been more accurate. And interestingly, no strategist predicted negative returns for years with the greatest losses (2001, 2002 and 2008).

What we aim to do is create a low-cost, balanced and globally diversified portfolio and then gradually shift asset mix and geographic weightings based on our longer-term economic forecasts and changes in broad fundamentals such as corporate profitability. With any luck, we’ll minimize volatility and generate a reasonably predictable long-term rate of return. But we’ll never be able to tell you the exact percentage return of any particular market in any given year. We’ll almost certainly be wrong.

And that’s a prediction I guarantee to be accurate.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.