Should you time the stock market?

The recent ‘Trump rally’ demonstrated just how challenging equity market timing can be. Few investors predicted a Trump victory. Of those who did, even less predicted the subsequent equity market rally.

In this research insight, we explore the arguments for and against market timing, and ask the question ‘should you try to time the stock market?’ Whilst market timing looks compelling on paper, we suggest, it is almost impossible for investors to time the equity market efficiently and consistently.

Trumped timing: Few investors picked the equity market rally post Trump victory

S&P/ASX 200 Accumulation Index

S&P/ASX 200 Accumulation Index

Source: IRESS, 2017

Market timing looks compelling (on paper)

Stock markets move in cycles. Investor who use market timing try to anticipate these cycles using macroeconomic data and other variables. As an example some investors will move part or all of their equities exposure to cash in anticipation of a market correction. The reason investors attempt market timing strategies is because of the large payoff available if they succeed as shown in the chart.

A significant opportunity? Missing the ten worst days in the market

Accumulation of $1000 invested: S&P/ASX 200 Accumulation Index

Accumulation of $1000 invested: S&P/ASX 200 Accumulation Index

Source: Macquarie

Beware the market timing mirage

Although timing the stock market is compelling on paper, correctly predicting the next equity market phase or correction is a complex and costly problem for the following reasons:

  1. Predicting market phases consistently is near impossible for most investors
    Investors are not always rational and equity markets do not always conform to logic.

  2. Market timing opportunities are limited
    A large proportion of significant market timing opportunities in the Australian equity market were concentrated between 2007 and 2009. Outside of this time period, the opportunity set for timing the market in Australian equities has been relatively limited.

  3. High portfolio turnover and trading costs
    Regularly switching your entire portfolio between cash and equities results in increased costs including tax implications. The high costs incurred in market timing means the strategy won’t work for many investors.

Should you time the stock market?

Investors and investment managers alike have fallen for the allure of ‘moving to cash’ at the right moment, only to have the equity market leave them behind.

As Peter Lynch famously warned, ‘far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in the corrections themselves.’

Whilst market timing is compelling on paper, the complexity in predicting equity market cycles combined with high trading costs make it impractical for most investors. In our view, an easier way to generate long term returns from the stock market is to keep your equities exposure invested.