Covid-19 Diary Number 9 (July 31, 2020)

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Frequently in these posts, I have warned against market timing.  Though timing buy-and-sell decisions of individual stocks can have merit, timing such decisions in anticipation of moves in the overall market is simply too dangerous and is as likely to produce failure as it is success. By contrast, buying and holding a portfolio of stocks for the long term puts history and probabilities on your side.  The timing temptation is nonetheless ever-present and is especially intense in times like now, when the pandemic has birthed extreme market volatility.  So this might be a good time to explain exactly what an investor is doing when he or she decides to time market moves.

 The ultimate theoretical commentary on this subject comes from Prof. Burton Malkiel’s A Random Walk Down Wall Street. In this book, first published in 1973 and the latest edition in 2019, he argues that most investors continually digest the endless flow of information coming from the economy, politics, and specific bits of business news, and use this information to assess existing stock prices and whether to buy or sell.  But these continual price adjustments, the professor demonstrated, happen almost instantaneously; and because no one can know the next bit of news, the market appears to move in a random pattern from day to day, even moment to moment (hence the title of his book).  Whatever you see in the news, Malkiel demonstrated, the market has already digested and adjusted stock prices.  There is no way to get ahead of the process.

Much of the financial community agrees with Malkiel, though these practical men and women hesitate to describe the market’s reality in quite the definitive way he does in his theoretical exposition.  Sometimes, they say, some people can anticipate market moves, and not all moves are entirely random.  To make the point, Wall Street tells a joke at the professor’s expense: If you are walking down the street and see a five-dollar bill on the pavement, the good professor will tell you that it really isn’t there, that someone else has already picked it up.  The Wall Street crowd claims that sometimes the five-dollar bill really is on the pavement – meaning you can sometimes have a sense of the market’s next move.  Still, most practitioners understand Malkiel’s point and warn that timing efforts are always fraught.  To see why, consider how market timers implicitly claim to possess one of two nearly impossible abilities:

  1. The timer effectively claims to know the news before the fact. If this timer sees good news coming, he or she buys in anticipation of the market’s coming upward price adjustment.  If that timer anticipates bad news, he or she sells in order to re-buy at lower prices when the market gets the news and adjusts prices downward.  This market timer is acting on the assumption that he or she can see the future – a most dubious claim.
  2. The market timer may not claim an ability to see the future but effectively asserts that the mass of investors operating in the market have collectively misjudged the meaning of the available news and accordingly have priced stocks incorrectly. If this timer thinks that pricing is too low, he or she buys in anticipation that the market “will come to its senses” and adjust prices upward, regardless of the continuing flow of news.  If the timer thinks pricing too high, he or she sells in anticipation of the opposite adjustment.  Here, too, is a dangerous arrogance that the market timer knows better than anyone else where pricing should be.

Such insights – whether on the future or on appropriate pricing – come rarely and are as likely to be wrong as correct.  Acting on market timing is always dangerous.  Sometimes, however, investors show such irrational enthusiasm, or such unlikely despair, that the claims behind an investor’s timing decision do not look as outrageous as they otherwise might.  In such rare cases, timing may have a place, but even so, investors should not kid themselves about the risk involved.

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