Buy. Sell. Buy. Sell (Repeat 'til broke)

Michael Goldberg

Collins St Value Fund

For as long as there have been markets, there have been people looking for ways to gain an advantage. From scams and fraud in under-regulated markets before the 1990’s, to systems and processes in more modern times, many people have found legal (and illegal) methods to gain an advantage.

In modern times, finding an information advantage has become increasingly difficult.

While once, a savvy investor could, through their time and effort uncover information advantages not available to the masses (think early value investors), with the advent of the internet and the availability of information, many of those opportunities no longer exist.

Today, hopeful investors seek other advantages. Of the more popular modern choices are; reading the market via technical analysis (charting), or making best efforts (usually through gut feel) to gauge the market. In reality, both are different versions of trying to time the market.

What does timing the market mean?

Timing the market is the practice of attempting to predict how the stock market will behave in the near term.

While some attempt to establish their position through the complexities of technical analysis, many others rely on gut feelings or their assessment of the economic outlook.

At Collins St Asset Management we don’t ascribe much weight to the concept of Technical Analysis. Our view is that if it were to work in principle it is faulted by the rule of diminishing returns.

If it did work, other investors would catch on and close the advantage. Moving averages and trading patterns are concepts that are so well known that to our minds it seems highly unlikely that investors can gain an advantage from them.

Tracking economic activity is a concept that resonates more strongly for us, however from a broader market position, economic activity has not proven to be an accurate indicator of stock market movements. This isn't because there is no correlation between market prices and economic activity, quite the opposite. In the long term, share markets and economic activity move broadly in tandem. The issue lies in which is the leader and which the follower in the correlative relationship.

Our experience has shown that stock markets tend to act as leading indicators of economic activity. That is, markets attempt to predict what economies are about to do.

When markets accurately predict economic activity we tend to see smooth adjustments to indices. More often, markets underestimate or over estimate actual outcomes leading to larger swings in share market indices.

Therefore it appears to us that estimating what the economy might do in the future is going to offer little value in the way of predicting how market indices might react right now.

“After nearly fifty years in this business, I do not know of anybody who has done it successfully and consistently. I don’t even know of anybody who knows anybody who has done it successfully and consistently”
                                                                  On Timing the Market - by John Bogle                                                                                 Vanguard Group CEO and Founder

Some might suggest that attempting to time the market is enjoyable, it keeps them engaged with current events and in any case, what are the risks?

The risks of being disengaged from the markets are surprisingly well documented.

When professional investors promote the idea of time in the market over timing the market, it is based on the following:

Over the last few decades on average, missing just the five best days of the year would have reduced an investors total return by greater than 90%.

The following graph highlights the difference in return over the last 15 years if an investor missed just the 20 most lucrative days of the period (equating to less than two days a year on average).

An investor who missed the best 20 days of 2004 to 2020 could expect to see the value of $10,000 invested fall from a potential $41,766 to just $17,813.

Studies done by University of Michigan and other US institutions showed that missing the best five days between 1996 and 2015 would have cost an investor 50% of the returns they would have earned had they simply bought and held over that period. Similarly, missing just 90 days over the 30 years 1963– 1993 (just 3 days per year on average) would have seen an investor of US markets give up 95% of their potential returns.

Granted it is similarly likely that an investor could miss the worst days of the year just as they could the best, but when returns have been so good from stock markets over the years it seems irresponsible or at least unwise to risk missing out.

This is especially true given that most of the best days fall immediately after some of the worst. This phenomenon tends to lead investors to act at precisely the wrong time.

Should I always be fully invested?

The simple answer if an investor has chosen to invest in an index is yes. Over the long term the best results are generated simply by being invested.

As Warren Buffett stated in his letter to shareholders (emphasis is mine):

“The Dow Jones Industrials advanced from 66 to 11,497 in the 20th Century, a staggering 17,320% increase that materialized despite four costly wars, a Great Depression and many recessions... Charlie and I believe it’s a terrible mistake to try to dance in and out of ... The risks of being out of the game are huge compared to the risks of being in it.” 

Dollar Cost Averaging:

Though the data is pretty clear, that time in the market rather than timing the market is the key, investing personal capital into the stock market remains an emotional decision. As such, there is a popular concept called “dollar cost averaging” that seeks to reduce the risk of investing all of one’s capital at the wrong time.

Essentially, instead of investing all of ones capital today, an investor might chose to break up their investment into 10 equal parts, allocating that capital gradually over time. Instead of investing $1 million today, an investor could invest $100,000 per month for the next ten months.

Though this will ensure that an investor does not allocate all their capital at the worst possible time, the data shows that historically, delaying investing generates a comparatively inferior return to lump sum investing. Though it is a systematic approach (which is better than gut feel), it remains a form of attempting to time the market.

Given all that has been said, investors might wrongly assume that there is no way to identify what might make a good investment. This is untrue.

There are several effective ways of identifying individual companies (and perhaps even indices) as attractive.

The following graph highlights that purchasing companies that are cheaper than average tends to generate a better than average return over time.

Is it possible to identify when markets are cheap?

It is in fact possible to identify when markets are cheap. The challenge in timing the market isn't in establishing when markets are cheap or expensive, the challenge is in pinpointing when the market is due to turn around. And therein lies the problem.

Just because a company or market has been identified as cheap or expensive does not mean that they will revert to properly priced in the near term. In fact, we’ve often seen companies that we thought were already expensive continue to defy gravity and push higher. Similarly, we’ve seen companies that we thought couldn't possibly fall lower do just that.

As this table shows, it is obvious when the market is cheap on an historical basis, and it is obvious when it is expensive. However, it is near impossible to determine how quickly things will recover or normalise.

Additionally, identifying anomalies is not especially helpful in normal times – and most times are normal.

For instance, in the last 26 years there have only been 6 times when the markets Price to Earnings Ratio diverted meaningfully from the average by more than one standard deviation.

It would be quite a challenge to build and manage a portfolio if adjustments were only made in extreme circumstances.

How we manage exposure

We don’t take a view on broader markets. We’ve found that attempting to do so has rarely generated good outcomes for us. Instead we’ve discovered that it’s far better for ourselves and our investors if we stick to what we are good at - picking individual companies with cheap stock.

We aren't looking to time the market or dollar cost average, but averaging down is a natural consequence of our process. If opportunity presents, we will buy our full position as speedily as possible. If the price later falls, we will happily buy more to maintain our designated weighting. This has the effect of averaging down our cost price but our consideration is that we simply want more of a company that we like.

By virtue of our investment approach we tend to find ourselves with more cash at the ready as markets correct and fully invested when markets are at their lowest.

We simply seek to be fearful when others are greedy, and greedy when others are fearful.

Be fearful when others are greedy and greedy when others are fearful.”  Warren Buffet

Though the concept resonates with most, the implementation is difficult. As we previously discussed most investors tend to do the opposite.

Physiologically investors would rather be part of the crowd than take a contrarian position. 

Additionally we believe that most investors fail to understand what makes a market: Rather than a perfectly priced single entity, the market is a great collection of over 2,000 individual companies, driven by their earnings and millions of individual investors expressing their emotions through their purchasing and selling activity.

As far as we’ve found, it’s very difficult if not impossible to read that activity with any hope of consistently predicting it in the short term.

What we can do is continue to buy companies that are cheap and sell them once they have become expensive.

In the meantime, we are happy for the market to do what it has always done: provide talking points for the financial news and broadly confuse anyone trying to make sense of the billions of individual decisions that drive the market every single day.

Michael Goldberg
Managing Director and Portfolio Manager
Collins St Value Fund

Michael is the MD and one of the founding partners of the Collins St Value Fund. The Collins St Value Fund is one of the best performing Funds in Australia - having ranked among the top 10 performing funds across all Australian Equity mandates by...

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