Market Timing?

Research on Safe Withdrawal Rates

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Mike
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Market Timing?

Post by Mike »

According to an article in the Wall Street Journal, high net worth individuals have as a group been adept at anticipating market movements. They moved into bonds in 2001, and back into equities as the economy started to recover. Studies show that most people seem to be poor at market timing, but most people are not high net worth individuals either. This would seem to hint that less than 1% of the population could have enough financial savvy to successfully market time, mostly the same people with enough financial savvy to accumulate large amounts of wealth in the first place.

None of this would invalidate the studies that show the majority lose money when they try to time, and are better off buying and holding the index.

http://online.wsj.com/article/0,,SB1087 ... ts_news_us
hocus2004
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Post by hocus2004 »

"According to an article in the Wall Street Journal, high net worth individuals have as a group been adept at anticipating market movements."

I haven't read the article, but I think you are onto something important with this post. I very much appreciate you putting it forward.

There is data that shows that middle-class participation in the stock market goes up in bull markets and down in bear markets. Yet there has to be a seller for every share for which there is a buyer. When we are in the middle of a white-hot bull market, there is some group of people selling a whole bunch of shares. If the middle-class is purchasing, some other group must be selling.

I raised this question in a thread on the FIRE board a long time back. I don't think we reached a satisfactory resolution of the puzzle. My guess, though, is that the most important factor is the factor that you are making reference to. I think it may well be that a good number of wealthy investors have learned the benefits of long-term market timing (presuming that it is long-term timing rather than short-term timing that the article is talking about).

In number terms, there are not many investors in the wealthy class. Most are middle-class. In dollar terms, however, the wealthy class probably controls as many shares as the middle-class. There are relatively few wealthy investors, but they control a disproportionate number of the shares in play at any given time.

I am not saying that this is so for certain. I am putting it forward as a possible explanation of some so-far unsolved riddles. If this is so, I think it has lots of implications for future projects at this board.

The tentative title for the book I plan to write on SWRs is "Why 'Stocks for the Long Run' Is Wrong." I want to address one of the questions that comes up in these discussions all the time--How did middle-class investors get it in their heads that long-term timing is not possible? It is clear that lots and lots of people believe this with all their hearts. It is also clear from even a casual look at the historical data that it is not so. Long-term timing has always worked and we have every reason to believe that it always will.

I believe that there are two types of people giving money advice, the well-informed and the not-so-well informed. People like Bogle and Bernstein and Burns are well-informed. Some of the people writing magazine articles and appearing on television shows are not so well informed.

The not well-informed are misunderstanding what the studies say. They have been told that there is a study somewhere saying that timing is impossible. They probably have never looked at the actual study. They don't realize that the study examines only short-term timing, not long-term timing. They jump to the conclusion that all forms of timing are impossible.

It may be that there are some people in the stock-selling industry who encourage these misperceptions. It wouldn't surprise me too much to discover that that were true. Perhaps reporters go to people in the industry to "explain" the studies to them, and they are told things that are technically correct but which sends them down a path which just happens to lead to them advising their readers that stocks are always the best long-term investment class. I worked as a journalist on Capitol Hill, and this doesn't sound too far-fetched a scenario to me.

The informed money advisors know better. But they are in a tough spot. Anyone who has seen what has happened to me and JWR1945 on these boards should be able to figure out why. When the majority is uninformed, it is sometimes better to pretend to be uninformed yourself. Otherwise, there are consequences to be paid. I don't do this for money, so saying unpopular things is not impossible for me. If I had to keep my readers happy to put food on the table, it might be a different story.

My sense is that Bogle and Bernstein and Burns and Arnott and Shiller and Smithers and Easterling and lots of others know the score. They all have made statements in support of the idea that changes in valuation levels affect long-term returns in a serious way. My sense is that what they are doing is providing just enough information about what they know so that they are "covered" when stocks go down. They will be able to tell their readers that they pointed out the pitfalls of becoming overly committed to stocks at times of extreme valuations.

But it's asking a lot of someone who makes a living giving money advice to put the pieces of the puzzle together, to not only note that valuation has an effect but to actually spell out what the implications are for portfolio allocation decisions. If you do that, you are going to get killed.

My guess is that most of the informed advisors try it once or twice early in their careers, see what the consequences are, and then fall into a strategy of sharing the most that they feel that they can get away with without bringing on too much heat. They provide enough information as to what the data says so that those of their readers who are willing to explore things deeper by themselves are sent onto the right track. They probably tell themselves (they may be right) that there is just nothing that can be done for those who do not explore things for themselves.

I believe that another factor at play is that the informed advisors have a keen understanding of the limitations of the average investor. They know that most people do not have the time or inclination to study investing in depth. That's why they try to put forward these simple rules of thumb--"put x amount in something non-volatile as a safety cushion and put the rest in stocks." The theory behind these rules of thumb is that the average investor needs a no-muss, no-fuss approach.

The rules of thumb have turned into a monster and now no one can figure out how to get the monster into a cage. The idea that stocks are always the best investment for the long term has been pushed for so hard for so long that lots of people now believe that there is some mystical law of the universe that it must be so. The reality, of course, is that there is no such law. The reality is that, when you reach the point where most people think that long-term timing is impossible, you have also reached the point where long-term timing is imperative.

I believe that there will be a search for new rules of thumb after lots of people lose lots of money as a consequence of their dogmatic belief in rules of thumb that make no sense at today's valuation levels. I believe that the data-based SWR tool may be the answer to the question that people will be asking at that time.

I hope that people will not want to give up on stocks; middle-class investors need stocks for their growth potential. But for middle-class investors to decide on their stock allocations without making reference to the effect of changes in valuation levels is suicidal. Lots of people are going to experience severe life setbacks as a result of the confidence they have placed in foolhardy rules of thumb telling them that putting 74 percent of their money is "safe" at any valuation level that ever applies. What is needed is a tool that provides balanced guidance, that supports the idea of making a healthy commitment to stocks but tempers that support with a dose of reality.

That's the role that I see the data-based SWR tool playing. The new tool does everything that the old conventional-methodology tool did. It just does one important thing extra. It incorporates data on the critical factor of changes in valuation levels into the mix. That one change increases the power of the SWR tool ten times over. Add in that one change, and you get an accurate assessment of how your investment will perform if the future is like the past rather than an inaccurate one. Accurate is 10 times better than inaccurate, in my view.

I believe that there is a good chance that a good number of wealthy investors are already taking changes in valuation levels into account in their investment decisions. These people have enough money that it makes sense for them to figure out for themselves how stocks work and not to just rely on dangerously over-simplified rules of thumb. I am trying to open up a strategic insight now appreciated only by the weatlhy to middle-class investors as well.

A lot of the research work we do is complex. People don't like to work through it for that reason. Lots of people are disparaging the tool without first going to the bother to find out what it is and how it works. But the finished tool is not going to be complex. There will always be complexity in the insides of the machine. But the finished product will provide a simple means for a middle-class investor to determine what his allocation should be presuming that the future will turn out something like the past.

In the end, we will have a tool something like FIRECalc, something you can plug numbers into and get a quick reading from, something you can play around with just for fun. You can't start with that. You have to do the analytical and statistical work first or the tool is going to provide the wrong answers. We have to work our way through some complexity now so that we can have a tool that is both simple and accurate later.

The tool is already simple enough if you are asking a simple question. And it is already reasonably accurate for a lot of not-so-simple questions. But it is not in a finished state. I think that makes the work done at this board exciting. At other boards, you are just discussing work that is already complete, you are just trading thoughts on something but not really having a personal impact on the issue at hand. At this board, everyone who contributes is helping to build a tool that in the future will help hundreds of thousands of middle-class investors gain access to the insights already employed (probably) by lots of wealthy investors today.

This is why I say in the "About This Board" post that the purpose of the Board Project is to change the world. I am not kidding about that. Helping a middle-class investor move up a notch means something. People who contribute here make a big difference. Most people want to do some good in the world and I believe that this board offers an unusually appealing way of doing so.

This is one of the reasons why I take such exception to people who disparage the board. What have we become that we ridicule a group of people trying to develop a tool with the power to change hundreds of thousands of middle-class lives for the better? Is our complacent belief in the "Stocks for the Long Run" paradigm so great that we cannot even permit questions about it to be raised on a discussion board?

Anyway, I liked the post. You brought up a point that I would like to explore in far more depth in future days.
Mike
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Post by Mike »

In dollar terms, however, the wealthy class probably controls as many shares as the middle-class.
Actually, they control a lot more than that. The top 5% control 60% of the wealth in the US. The top 10% control almost all of it. The top few have always controlled most of the wealth in this country. The main change in the last few of decades in terms of equity ownership has been the growth of wealth controlled by by pension plans, including defined benefit plans, public pension plans (schools), and to a lesser degree 401ks, and IRAs. Pension plans went from about 1% in the 1950s to about 25% today. They have had to offer more than past prices to get the wealthy to part with some of their shares. As a group, the middle class owns relatively little in the way of equity in personal accounts. Even the bulk of 401k/IRA ownership tends to be concentrated near the top. The median 401k balance is pathetic.
unclemick
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Post by unclemick »

Bernstein and Bogle each in their own way have fired shots across the bow of the 'institutional class' the 'managers' (top 100 ?) who run the bulk of the market - their herding instinct, accepted dogma, and when they panic - watch out.

My vague memory says Ben Graham put forth a 'modest criticism in 1972 of the 70/30 stock/bond allocation of many pension funds - not tooo long before 73-74. Wonder if they readjusted at the bottom - and then, and then Congress gave us Pension Reform. ??? Some of the labels have changed, but Congress is still here and my defined pension is still projecting 9% ? long term.
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Post by unclemick »

Oooops! I meant top 100 institutions - the number of managers delegated to 'run' the money is way higher - thousand's or more? Still a select group prone to herd instinct.
Mike
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Post by Mike »

...'institutional class' the 'managers'...
True, but they are just hired hands constrained by legal requirements and the need not to underperform their peers, not people managing their own fortunes. The WSJ article suggested that the rich tend to manage their own personal money better than average. There are exceptions, of course.
th
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Post by th »

Perhaps we're merely mistaking the cause and effect.

Is it that high net worth individuals time the market well, or that they're high net worth individuals as a result of a couple of lucky market times?

I got out in early 2000 and went into reits and balanced indexes. I wanted to get out in late 99 but decided to wait until after 1/1 to defer the tax hit another year. I would have missed another 25% rise had I bailed when I wanted to. Lucked out with the reits and balanced index funds when those did well through the end of 2003.

No special knowledge or skill, pure luck. But I'll take luck when its there.

I love snooping through causes and effects. My favorite for reversals is the pedestrian football stats, like "this team is 10-0 when Joe Zoomer runs for over 100 yards, so the coach is looking to get him the ball". Hmm, could it be that Joe Zoomer ran for 100+ yards because they were thrashing an inferior team and wanted to run out the clock? The sport is rife with these upside down stats.

Although my favorite of all time, dating back into the 1980's, was a classic Madden-ism: "This team gives up over 100 yards to any running back named 'Barry'!!!". In the day of Sanders, Word and others...
He who fights with monsters might take care lest he thereby become a monster. And if you gaze for long into an abyss, the abyss gazes also into you. - Nietzsche
Mike
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Post by Mike »

Is it that high net worth individuals time the market well, or that they're high net worth individuals as a result of a couple of lucky market times?
Good point, in many cases this will just be luck. However, the fact that the rich tend to get richer argues that at least some of the time real skill may be involved. People who amass fortunes tend to amass even more over time, and their heirs tend to lose it over time. The people who were just lucky tend to have their luck run out, unless they are humble enough to get real conservative once they have enough to live on for the rest of their lives.

Come to think of it, the rich's current 35% equity is still very conservative. They mostly seem to be trying to avoid major losses, rather than trying to aggressively make more. They already have enough to live on for the rest of their lives, and only have to avoid taking big risks in order to maintain their security. In view of this, going to 20% equity a few years ago, and bumping it up to 35% now may be more of an attempt to avoid losing big, rather than an attempt to beat the TSM.
th
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Post by th »

Mike wrote:Come to think of it, the rich's current 35% equity is still very conservative. They mostly seem to be trying to avoid major losses, rather than trying to aggressively make more. They already have enough to live on for the rest of their lives, and only have to avoid taking big risks in order to maintain their security. In view of this, going to 20% equity a few years ago, and bumping it up to 35% now may be more of an attempt to avoid losing big, rather than an attempt to beat the TSM.
That was going to be my next point. If you look at the portfolio's of the very rich, they're heavy with bonds and other instruments that really only the very rich and connected get to participate in. Even with giving out tons of cash and building massive monuments to live in, 5-6% of a few billion a year just goes to making you richer, inevitably. Not much magic there.

How they got there is more "luck". Many of the worlds wealthy got there on the backs of a single stock, the one of the company they run or are a senior manager of. Is Microsoft's software the very best out there? Hardly. Is Bill Gates the greatest manager of all time? I met the guy in his 20's, I thought he was an idiot. He made a bet on facing down IBM over the windows vs OS/2 long term OS strategy, and then IBM managed to step on its own dick about 11 times in the next 18 months, creating the opening windows needed. After that I must say the management team at Microsoft has done a terrific job of building and maintaining a near monopoly position and milking a bunch of downer cow products.

So it seems the strategy is two-fold: exploit an event/seam with a highly concentrated portfolio to shoot yourself into a financially superior position, then become highly conservative and take advantage of that position to generate high yielding, low risk investments...perpetually inflating your money pool.

A good question is "why dont the very rich exploit a key concept of many ER's, the almost certainty of rising stock prices over long periods of time?". A two-fold answer there. Because they know that their money could disappear through the same seam it appeared through, and of course because they dont have to.

Or you can be Warren Buffett.
He who fights with monsters might take care lest he thereby become a monster. And if you gaze for long into an abyss, the abyss gazes also into you. - Nietzsche
peteyperson
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Post by peteyperson »

I'll jump in at this point.

The Merrill Lynch World Wealth Report is an enjoyable publication. It does however give the impression that the rich are nimble or that their advisors are nimble. Given who writes the report, Merrill Lynch, a not unsurprising conclusion..

I'm just not buying it. Unless the equity holdings have stop losses, then it is not a simple matter to get out of a market that moves up and down daily, minute by minute. Furthermore, to try to time in and out and still make a good return long term is almost impossible because you take on the mindset of a trader rather than a long term investor. And they're sort of oil and water. Also, those that are timing the market as too high, would have moved out of equities some time ago at the level of PE we have. So I'm just not buying it.

My plan is very similar to what you say. To invest in a concentrated manner in a selection of excellent businesses that I feel will have materially larger earnings in 20 years time. I cannot know the prevailing PE multiple in the future, so I would project earnings growth and a sale price that falls in a range of PE multiples. It is also possible that rather than needing to sell a complete position for living expenses or to close out the position incurring capital gains tax all in one go, I might hold the company into retirement and ultimately sell it off piecemeal at a range of PE ratios. It is worth noting that Warren Buffett has always said that he ignores the economic realities and simply buys strong businesses. He does stay high in cash when stocks are pricey but he also has fewer businesses to choose from in the public market and the price moves up considerably as he tries to build a substantial position. So his challenges are quite specific to him and not the private investor.

Once I reach a point where I have enough to live off, there will be a considerable temptation to diversify investments. One investment I am considering currently is St. Joe, a Florida land owner and developer that is developing communities for baby boomers and plans to retain some properties for continued income after the baby boomer properties have been sold by 2017 when most boomers reach retirement age. The fall off may make a full sale of St. Joe necessary and I would be inclined to move the funds into a small selection of Global REITs. This would provide a lower long term return but include a 4%+ yield which would help smooth out years when equities have lost substantial capital value. You pay an opportunity cost for that as real estate carries a mixture of bond and equity-like attributes which deliver returns partway between bonds and equities with standard deviation between them too. In the last decades for instance, REITs produced a return that fell closer to bond returns than equities.

Some level of diversification is useful to protect against the situation where equities fall 50%+, inflation goes up 10% per annum which it did for 5 years straight in the 70s/80s and you're eating into capital any way you slice it. Bonds really don't help. Their net of tax real return is marginal at best. Equity-like investments and absolute return strategies are a better mix instead. Bonds other than Treasuries held in long maturies for protection against deflation are poor investments. TIPS are also pretty useless as they are still low returning bonds but use an always unreliable CPI value to adjust up. Bit better than a regular bond that loses much to the ravages of inflation but if the data isn't reliable then you're still left with a highly tax efficient low bond-like return.

All that said, when you reach a stage where you research companies and form your own opinions, then you are unlikely to want to go back to indexing. Knowing when to buy and sell an index fund is a tricky thing as you have no total view on the businesses or the market. You cannot tell, for instance, whether US business as a whole is seeing lowering profit margins or return on equity. Whereas, with something like St. Joe, I bought in with specific understanding and planning in mind and had a good idea what would cause me to sell. This makes managing investments a lot easier. Also, there is a perception that investing in fewer businesses is riskier than many. The idea being that owning a large number of average to bad companies with a few good ones sprinkled in is preferable to owning a much smaller selection of good to excellent businesses that you understand and believe in. I for one could not understand a large shift into buying what I don't know or understand well, having delivered good performance in my previous analysis. There is no reason that you would suddenly lose those kinds of skills and as Buffett has said, he's gotten better as he's gone along. Considering where I started from, so have I. If you stay within your circle of competence and possibly expand it as you go along, you should do fine.

Petey
th wrote:So it seems the strategy is two-fold: exploit an event/seam with a highly concentrated portfolio to shoot yourself into a financially superior position, then become highly conservative and take advantage of that position to generate high yielding, low risk investments...perpetually inflating your money pool.

A good question is "why dont the very rich exploit a key concept of many ER's, the almost certainty of rising stock prices over long periods of time?". A two-fold answer there. Because they know that their money could disappear through the same seam it appeared through, and of course because they dont have to.

Or you can be Warren Buffett.
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