• ETF Insights

    Market Timing, the Fool’s Game

    Martijn Rozemuller, CEO – Europe
     

    There is a waiting game going on in equity markets. Wary of the contrast between deep recessions and markets that are at all-time highs in some countries, people are sitting on cash – waiting for markets to correct significantly before they start investing (again).

    They look back in envy to previous market crises when major corrections proved to be significant buying opportunities. During 2008’s Global Financial Crisis, for instance, the MSCI World Index of large global stocks dropped almost half, by 48%. And, in 2002’s dotcom crash there was a correction of 55%. Hoping for a similar buying opportunity, they are waiting with great patience.

    I fully understand the logic. It is natural at a time of great uncertainty for any risk averse person, including me. You want to avoid stepping in at the wrong moment, because the market might go even lower. But what if we are at the trough now? If professional active investors with large teams of people can’t time the market, what hope is there for ordinary investors? In fact, is market timing a fool’s game?

    I have written about the topic of market timing before, but I would like to do so again in more depth as it is so relevant at this time – and a subject close to my heart. If it were easy to time the market, lots of investors would be doing it and many, including me, would buy their own tropical island paradise. So, why is it so hard to successfully time the market?

    Let’s dive a little deeper in the underlying reasons.

    Active funds prove the folly of timing

    There are many actively managed funds that try to time the market with limited success. Known as multi-asset, mixed or balanced funds, their managers strive to jump between equities, bonds and cash at the right moment, catching the up waves and avoiding the down. These well-paid fund managers often have teams of analysts and macro-economists at their disposal, as well as elaborate computer models.

    In reality, though, their efforts add no value. As an example: Our own VanEck Vectors Multi-Asset Conservative Allocation UCITS ETF, which does not actively switch between asset classes, has performed better than 96% of the funds in its peer group during the last five years, (see figure 1). Of course, part of the reason for this is it charges much lower costs. It is not for nothing that Morningstar lauded this ETF with the “best mixed funds EUR award 2020”.

    Figure 1 – Market timing doesn’t work

    5-year performance comparison of VanEck Vectors Multi-Asset Balanced Allocation UCITS ETF with Morningstar EUR Cautious Allocation – Global peer group

    Market timing doesn't work

    Past Performance is not a reliable indicator for future performance. Source: Morningstar, VanEck analysis. Data as of 31 August 2020. Peer group consists of 534 funds, both active and passive funds. For each fund the oldest available share class is used.

    Four reasons why it’s fruitless

    Why is it so difficult to step in and out of the markets at the right time? In hindsight it is so easy to explain what happened in the past:

    1. It is difficult to predict the future. To use an analogy, even the most advanced computer models struggle to predict the weather. The same is true in financial markets where action and reaction can be unexpected. For instance, if capital markets fall then central banks will probably react. When and how they do is often unpredictable, leading to capital markets that also react in an unexpected way, which in its turns leads to investors being wrong footed. In short, market reactions are very unpredictable due to known unknowns and unknown unknowns.

    2. History is a poor guide to the future. Why? Patterns change (Mark Twain, the American author is meant to have said “History doesn’t repeat itself; but it often rhymes.”) When the corona crisis began in March 2020, the European Central Bank took just a few weeks to introduce quantitative easing, or debt purchases; far faster than the three years it took after the Great Financial Crisis. Additionally, structural macro-economic shifts influence events, such as today’s historically low interest rates. This begs the question: what’s the right valuation multiple for securities (see also my column from August)?

    3. Let’s not forget about psychology. You may have heard about investors’ behavioral biases, such as herding or regret aversion. What academics have discovered is that emotions play an important role in investment decision making. The fear of loss outweighs the joy of winning. I speak from experience when I say that my memories of losses are far stronger than those of gaining.

    4. Do not ignore opportunity costs. Waiting until a share (or index) has fallen back to a previous level means you do not take into account dividend income. The price level of shares and many indexes do not include dividends, and so they do not give the full picture. For instance, the US S&P 500 stock market index peaked in October 2007 and then fell to a trough in March 2009, appearing only to recover its high in March 2013. However, if you include dividends anyone invested in the S&P would have made their money back in April 2012, see figure 2. Anyone waiting for the dip would have missed both the upside and the dividend.

    Figure 2 – Return of S&P 500, rebased at 10/9/2007 (pre-crisis peak) = 100

    Return of S&P 500, rebased at 10/9/2007

    Past Performance is not a reliable indicator for future performance. Source: VanEck analysis. Data for the period 09/10/2007 – 28/03/2013. Dividends are net of withholding taxes.

    When being lazy is good

    So if market timing doesn’t work, what should you do?

    Investing, just like anything in life, is about avoiding avoidable risks. You could cross the street without looking left and right, and chances are you won’t be hit a bus, however you do reduce the risk significantly by looking. In investing, it is the same. Avoiding all risk is impossible, just like looking left and right might still get you hit by a rogue cyclist. There are however risks you can mitigate.

    The most important reducer of risk is diversification whether across asset classes, companies or time.

    Therefore, I recommend that you stay invested at all times, but diversify in the ways just mentioned, ideally in low-cost ETFs Your asset allocation should be adjusted over time based on your risk profile which might evolve. Financial theory predicts that over the long run you should reap the so called “risk premium” as a reward for putting your money at the disposal of companies (or governments).

    The additional advantage of staying invested is that it takes less time, and calms your nerves.

    And, diversifying across time means that you regularly buy into an investment, perhaps monthly, which is the wise person’s way of avoiding the fool’s waiting game of market timing.

    VanEck Vectors Multi-Asset Conservative Allocation UCITS ETF is a sub-fund of VanEck Vectors ETFs N.V., an investment scheme which is domiciled in the Netherlands and registered with the Dutch Authority for the Financial Markets and subject to the European regulation of collective investment schemes under the UCITS Directive. The sub-fund tracks share index and is managed by VanEck Asset Management B.V.


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