The cost of market-timing
With world markets looking like they will end the year well, it remains somewhat stunning just how disbelieving most people are about the strength of global equity markets.
This feels like the least euphoric rally I can remember in my 25 years in equity markets.
My general view is nowadays, investors have an unprecedented amount of short-term "noise" to navigate through. This "noise" is highly distracting and unlikely to lead to investors getting the maximum reward available from their equity investments.
Equities are volatile in the short-term, that is the nature of the beast. This is particularly so with high-frequency trading dominating the daily equity liquidity picture. There are even algorithms that trade off Twitter headlines!
However, over the medium to longer-term, the attraction of equities is the availability of compound total returns. You will only feel the effect of the compounding process if you invest for the medium to longer-term and resist the temptation to sell on every scary Twitter headline.
There are very few great short-term traders in the world because successful short-term trading is counter-intuitive to the basic makeup of average human psychology. Great traders sell into euphoria and buy into panic, which requires a different internal setting than most people are equipped with. Instead, what we need to do is really focus on being an investor. An investor's friend is time, duration, conviction and fundamental research.
I did publish this in a Livewire “key charts” series a while I ago, but I think it’s worth highlighting it again as the experience over the last 4 months supports what this chart is trying to portray. If you get the “timing” wrong, as most people will, it will severely effect the returns of your equity portfolio.
The chart below shows the MSCI World Net Total Return Index (USD) over the last 15 years (dark blue line) and the compound average growth rate it delivered of 7.1%pa.
Now we are going to explore what effect being “out of the market” on the “best” index return days had on annual returns. The red line shows the return generated if you exclude the “best 5” index return days in the last 15 years. The grey line shows the return generated if you exclude the “best 10” index return days in the last 15 years. The light blue line shows the return generated if you exclude the “best 20” index return days in the last 15 years. The green line shows the return generated if you exclude the “best 30” index return days in the last 15 years. The purple line if OECD G7 inflation.
You can see in the chart above the dramatic reduction in annual return that “missing” even a small number of “best” index return days generates.
If you missed just the 5 best index return days in the last 15 years, your compound annual growth rate drops from 7.1% to 4.8%.
If you missed just the 10 best index return days in the last 15 years, your compound annual growth rate drops from 7.1% to 3.1%.
If you missed just the 20 best index return days in the last 15 years, your compound annual growth rate drops from 7.1% to 0.8%, or less than inflation at 1.7%, a negative real return.
If you missed just the 30 best index return days in the last 15 years, your compound annual growth rate drops from 7.1% to -1.1%, negative absolute and real returns.
Yes, historic performance isn’t a guide to future performance, however the evidence above clearly reminds you of the importance of being invested on the major index up days. If you miss the major index up days you will miss the compounding effect of being invested in equities as an asset class.
Historically many of those major index up days have come after periods of index weakness, volatility and uncertainty. 2019 has been exactly the same and started from a very low point after the December market falls in 2018. But it wasn’t just the recovery from the 2018 lows, even the last six months has been very volatile.
The chart below is of the S&P500 over the last six months. It confirms that the return from the mid-August lows alone is now greater than +10%. That is akin to missing out on more than the annual average compound return from global equities over the last 15 years, in just 4 months.
I realise its an over-used cliché, but it’s right. Successful equity market investing is about time in the market, not timing the market.
What I’ve done in 2019 is cut all unnecessary noise of out my investment process. This is to the displeasure of the stockbroking community and to the benefit of my investors.
When you remove yourself from the noise and focus on long-term fundamental investing in the best businesses in the world, you will be positively surprised by the results compounding delivers over time.
Stay the course, it’s a long game...
Invest with conviction, not momentum
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