To Buy or Not to Buy; That is the Question

My eyes were wrestling between my phone and the beautiful glass ceiling of the restaurant. It was late August or early September 2011 and I was waiting for one of my most important clients to arrive for lunch. Nervous action potential was above average. This was technically supposed to be a catch up meeting. Yet, I knew a portfolio review was also on the tacit agenda.

My meeting was with the President / co-founder of several substantial companies. He is a big investor with us and sways several others. Luckily, he is also an all-around amazing person. One of the best. And we have done very well for him. There was no reason to be anxious really. But there was one thing. He told me he really didn’t like the outlook for the equity market two or three months prior because of all the noise in Europe, and I didn’t listen. This client never, ever provided a market perspective to me before this.

And so I sat there, somewhat seeping. The S&P 500 just having corrected >10% over the past three weeks(ish).  I hadn’t agreed with him a few months ago – only a year and a half after “economic Pearl Harbour” – and he was, so far, in the right. From my vista, the size of it was that Europe was concerning (the 1930s correction did double dip down after all), but it seemed manageable and there was good leadership where it counted. The Fed had also stepped up with a blank chequebook just year earlier. They were going to buy everything until the headlines went away.

It was fine. It was all fine…wasn’t it?…. cont’d at the last section below.

Can You Really Time the Market? Lets discuss this careful notion here. I say careful notion because frankly I am not sure having an educated view on where we are in a market cycle helps the average investor much beyond helping them sleep better. Trying to time the market with a spare time commitment will likely be costly relative to the bare bones averaging in approach. I appreciate my vulnerability on this topic and try to remember that my educated intuition has a very good chance of still being wrong. Nevertheless, here are a few things that seem relevant to this contemplation.

Some General Guidelines

• An investor can manage market timing risk by simply averaging into their investments over time.
• Equity markets have tendency to go higher over the long term. Oh, yes, there can be some very long breaks with the odd hefty correction in between. But, over the very long term, the cost to not being invested has been hugely disproportionate to the cost of being invested through a correction. Don’t believe me? See for yourself – S&P 500 Chart from 1950 to 2016
• Very short term equity market views come with little better odds than a roulette table, but longer term timing odds are much better. Re the WSJ, “own­ing stocks is mostly a win­ner’s game. Since 1928, the stock mar­ket has risen on 54% of days, 58% of months and 73% of years. Over that time, a $10,000 in­vest­ment in U.S. stocks in 1928 would have grown to $40 mil­lion.”
• Diversify amongst different equity markets and other asset classes to own things that are going up when other things are going down.
• Convincing yourself you can time the market often leads to bad habits. Investors more confident in their ability to market time tend to sell more often after a correction in an attempt to protect capital, but wait too long to buy back in. This can be very very expensive to your future self – effectively, selling low and buying high. To be clear, I also do not want to lose money and there are times to sell. Just be careful.

Technically Speaking

Some of the useful things I keep in mind when contemplating how much equity exposure include:

Momentum Rules the Short Term and Value the Long: Momentum and macro signals are useful over shorter time horizons. Strong (bad) performance in the recent past is, on the margin, more likely to be followed by further strong (bad) performance. However, over longer term horizons, which are more predictable, (intrinsic) value and income yield are the best indicators of price direction… Prices don’t mean revert. Valuations do.

Earnings Momentum – It is generally positive for stocks if the earnings per unit of the index is trending higher quarter-over-quarter.

Interest Rates – It is generally positive for the equity market if interest rates are low as investable cash is cheap and the opportunity cost relative to fixed income investments is lower. The shape of the yield curve has also been noticeably correlated to economic conditions. An inverted yield curve, for example, has almost always resulted in or coincided with an economic recession.

Increasing Money Supply – There has been a historical, statistically significant positive correlation between the performance of the S&P 500 and the US money supply growth rate (Maskay, 2007). It is generally bullish for stocks if the global money supply is expanding, as more capital is pushing through the offer stack.

Dividend Yields – Nothing new here. High valuations / low dividend yields tend to predate periods of below average returns.

Stupefactions – Is there anything brewing with the potential to compromise market stability?  Foreshadowing of the 2008/2009 crash, the Canadian commercial paper market effectively shut down in 2007. Then oil and natural prices rallied exorbitantly to $145 per barrel and ~$13 per MMBtu in the summer of 2008. These are big big costs to the world economy. Then credit spreads gapped up early in the fall. The bond market got pretty scared pretty fast and early. But, of course, these are convenient reflections smeared with hindsight bias, to which I say… fair enough. As the priceless comedian Mike Birbiglia put it so well, “Yes… I am in the future also”. 

cont’d from above…

It is tough to forget that hint of self doubt, waiting in that restaurant. The kind that, if you don’t overpower it, the voice will crack. In the end, both the client meeting and the market went very well. However, as bollox would have it, all my mind fuss at that time dispirited me from pursuing two huge concurrent opportunities. One was an unrelated, initial round investment in a new company led an elite management team. They were buying an asset that they thought they could triple cash flow from within two years. They were reputable. They were correct. I passed. Ouch. Amusingly, the asset they bought only came up for sale because of the (European sovereign debt) market jitters.

The second was quite literally directly under my nose at that client lunch. It turned out my client didn’t really care about the market that day. He also had a new private company and it was just launching an innovative new product. All he really wanted to know was what I thought about the product. Unfortunately for me (exclamation point), I was so focused on explaining our market positioning to him that I didn’t think seriously about his product, “seems really cool, anyway”. That was a very very very expensive distraction as I likely could have invested personally. Today, most people in the developed world now know someone who owns this product.