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Market Timing: How far will the market continue to move higher, before the drop arrives?

The 10 bear markets since 1929 combine for an average market drop of 45% over an average duration of 25 months. The bull markets that have preceded/followed those 10 bears have generated an average return of 154% over an average duration of 54 months. The current bull market, which began on March 2009, is well above those averages. The bulls just celebrated the 8th anniversary, and have cheered market gains of 231% through the end of 2016. With the market continuing to post impressive gains to start 2017, many investors are increasingly worried that a “pullback” is on the horizon. This increasing pessimism has many investors asking; “Is it possible to time the market?”
The simple answer: No. Although you may occasionally be right on the short term direction of the stock market, a problem with market timing is you have to be right twice. Not only do you need to sell (buy) at the right time, you have to buy back in (sell) at the right time as well. If you do raise cash, at what point do you feel comfortable going back in? The market can be extremely volatile over the short term and can move extremely quickly. The longer you stay in cash, the greater your risk of missing a strong recovery.
There are many popular studies that show the effect of missing out on the market’s strongest days. Over the last 15 years (1/1/02 – 12/31/16), a $10,000 investment in the DJIA at the beginning of the period would have grown to $28,698 — an average annualized return of 7.28%. If an investor were to miss just the 10 best days during this 15 year period, the ending portfolio value drops to $14,697, which is an average annualized gain of just 2.60%. Just 10 days produces a 4.68% difference in annual returns. It only takes missing the 20 best days during this period to produce an investment loss. Missing the 20 best days results in an average loss of -0.25%. Finally, missing the best 40 days during this time period cuts your initial investment in half. Your ending portfolio would be $4,908, which represents an average annual loss of -4.63%. You can clearly see that the majority of the market return is attributable to a select few trading days.
The past four months have proven to be a tough market for those trying to time it. The S&P 500 rallied 5% from the election through year end. Investors with cash in January may have felt that the market had gone too far too fast, and decided to wait until the next drop to buy in. January started strong and finished the month with an overall gain of 1.78%. The strong gain in January may have increased conviction that the market was overextended. However, February saw the market extend its win streak, advancing nearly 4%. Now what? It is inevitable that the bears will eventually be right and the market will fall. The question is, how far will the market continue to move higher, before the drop arrives?
Market timing is a tempting, yet futile strategy. A history of investor cash flows shows money continually chasing returns, buying at market tops and selling at market lows. This is because many investors let their emotions get the best of them. Investors will be successful in the markets through proper diversification and an asset allocation that aligns with their risk tolerance. The longer an individual is able to invest, the higher the probability of earning a positive return. For example, the S&P 500 has never produced a negative average annual return over a rolling 20 year period. This gives way to the popular saying: It’s not about timing the market, but time in the market.
Tom Reynolds, CPA & Matt Reynolds CPA, CFP®
Co-Managing Partners, CRA Financial
Francis C. Thomas CPA, PFS,
Investment Advisor
Robert T. Martin, CFA, CFP®,
Investment Advisor
This article is for informational and educational purposes only and should not be relied upon as the basis for an investment decision. Consult your financial adviser, as well as your tax and/or legal advisers, regarding your personal circumstances before making investment decisions.
This article first appeared in NJ Lifestyle Spring 2017.