Don't time the market

I subscribe to Insights, a blog by Goodreid Investment Counsel. The following is a window into the quality advice in that newsletter. If I were looking for an investment advisor, the team lead by Gordon Reid would be among my top contenders. At times, I have found the advice in the Goodreid letter to be what I would call "wise and financially astute."

Myth: Timing the Market Results in Higher Returns

It is true that if you could consistently time the market such that you bought securities at their trough and sold them at their peak you would earn higher returns, so why is this a myth? To answer this question, we can look at several variables. 

To start let’s examine the length of the business cycle. If we can predict the length of the business cycle or better yet the length of each phase in the business cycle, then we will know when we are at the peak (and therefore should sell) and when we are at the trough (and therefore should buy). 

In the U.S. we can observe that the average length of the typical business cycle is 4.7 years, but varies greatly from cycle to cycle, with the standard deviation of the average cycle length being 2.2 years. (Marmer, 2016)  With most cycle durations deviating up to 47% away from the mean, it becomes very difficult to predict each cycle length with any real accuracy. 

To compound this problem the average stock market cycle in the U.S. is 7 years long with a standard deviation of 3.1 years. (Marmer, 2016) With both the business cycle and stock market cycle having differing, and highly variable durations it becomes nearly impossible to consistently predict how long each phase will last in order to sync up your trades to maximize profits. 

We can also observe the difficulties of market timing on a more granular level. During 2019 the TSX had a price return of 19.1%, which is a figure you may have seen discussed in the media as we entered the new year. What you might not know is that of the 251 trading days on the TSX in 2019, the 19 best days account for just over 94% of the annual return. Obviously, it would be next to impossible to predict which of the 19 days of the year would yield these returns. 

Instead of timing the market it's better to develop a disciplined strategy to be in the market that considers both your willingness and ability to take risk. We know that markets go up over the long run so don’t let your portfolio suffer by potentially missing the relatively few days (in this case 19) of the year that can drive your overall return.

What is a correction? . . . a bear market?

A friend, new to investing, asked me to explain a correction. I don't have to do it as Derek Fuchs, writing for Scotia Wealth Management, has beaten me to it: What is a Correction?. The important points that I took from Fuchs piece:

• A stock market correction is defined as a 10% decline from the peak.
•  A stock market correction historically occurs every one to two years.
• Most stock market corrections are here only for a short time. Some have lasted only a few weeks. The average correction lasts around two months.
• While the 10% decline is considered a correction, most have an average decline of around 13%.

What is a bear market?

• A bear market is different than a market correction. A bear market is one where the market has declined 20% since the previous peak.
• Most corrections do not become bear markets.
• Typically, one in five corrections will become a bear market.
• A bear market can last normally around a year, with the average closer to 15 months; they can also be much shorter than that.

The proper investor response to corrections or bear markets.

• The rebound from these declines can often be swift, dramatic, and offer some of the best time to invest.
  

Try to buy low but not the lowest

When stocks I having been watching fall into correction territory, that's a time to buy. An investor friend told me not to go all in with the first purchase. Keep some cash in reserve to give yourself the option of buying more if the price continues to tumble.

A lot of folk hesitate when faced with a buying opportunity. They want to to time the market. They want to buy at the moment the stock hits bottom. This is almost impossible. The bottom is only clearly the bottom when the stock is well into recovery. Many claim, with good reason, that buying during the recovery is the best way to play a bear market.

Look at the chart of the CIBC stock price. The high for the year prior to the March 2020 crash was approximately $115.87. A correction kicked in when the CIBC stock dropped 10% to $104.28. If one bought some CIBC at the 14% correction mark, it would have been about three months before the stock revisited the correction purchase price. That's not a long time if you consider it would take almost a year for an investor who bought at the high to see his money returned.

The CIBC stock bottomed out at about 42% off its high. If you made your second buy at the 32% down level, you wanted to be fairly certain the stock price was recovering, you would have walked away with a real steal. The stock would have been selling for approximately $78.80. The recovery paused at this point, a little bad luck, these things happen, but you still would have climbed into the green on the second buy within weeks.

What have we learned? I'm not really sure. I do know my wife and I made out very nicely during the March 2020 crash. I bought the correction. She bought the bear. Now, to check some more stocks and some more charts. At some point, I believe there is a lesson here.