Crash Course in Market Timing Shows Cost of Being Wrong at Tops

It’s the eternal debate. Stocks are teetering. Volatility’s back. Do you ride it out, or take the money and run?

The question is obvious, the answer is not. Like now. Is it the end? Facebook and Amazon are in free fall, the yield curve is flat and the Federal Reserve is bent on raising rates. But profits are rising, the economy’s up and companies plan billions of dollars in buybacks.

Behind it all are facts of investing known well by anyone who sold after Brexit, the U.S. election, or five market corrections since 2009 that look just like this. One, it’s hard to see the end of things. Two, a lot of money is made at the top. Three, you miss any payoff in equities right now at grave risk to your career.

“It can be 6 or 8 percent costly, or even 10 percent costly” if you bail too soon, said John Augustine, chief investment officer for Huntington Private Bank in Columbus, Ohio, in an interview at Bloomberg’s New York headquarters. “That can mean a lot to folks in a 2 percent nominal world.”

It can actually mean more. A study by Bank of America Corp. on market peaks since 1937 shows that being uninvested in the last year of an advance meant foregoing one-fifth of the rally’s overall return. While every episode is different, that math translates into additional 470 points in the S&P 500, if the bull market goes on for another year.

Topping Process

“The market’s topping process tends to create this higher return environment, which makes it tough for investors to assess where we are,” said Matt Forester, chief investment officer who helps oversee $7.9 billion at Lockwood Advisors Inc. in King Of Prussia, Pennsylvania. “The process can go on for a while and it doesn’t change on a dime.”

Even the worst declines are often erased, meaning an ill-timed decision to sell is usually a bigger mistake than waiting for the bottom. Over the last eight decades, the S&P 500 has advanced a median 21 percent in the year prior to a market top, compared with a 15 percent decline in the year that followed. The gains were big enough to overcome losses over the ensuing year 67 percent of the time, data compiled by BofA show.

“I’m ahead of the game by just sitting tight,” said Scott Clemons, chief investment strategist at Brown Brothers Harriman & Co. in New York. The firm oversees $32.1 billion in private wealth assets. “I’d interpret that as a case statement for the wisdom of not trying to time the market.”

Research into the risks and rewards of market timing goes well beyond BofA’s study. One line of inquiry focuses on the penalty an investor incurs by sitting out the biggest single-day gains in the market.

A 2011 study by Meb Faber of Cambria Investment Management found that missing roughly the 200 best days between 1928 and 2010 cut annual returns in equities from positive 4.9 percent to minus 7.1 percent.

At the same time, if someone managed to miss all the best and worst days, he did a little better than average, and the author suggested strategies may exist for pulling that off. For one thing, volatile days cluster when the S&P 500 trades below its 200-day average.

Going by that logic, investors better watch out. The benchmark index this week slipped below that threshold for the first time in almost two years. While still nowhere near the crisis days of 2008, the S&P 500 has risen or fallen 2 percent seven times this year, compared with zero in all of 2017.

Is this the end? It’s all they want to know on Wall Street right now. Driven by stress in the Faang group, the Nasdaq 100 has now risen or fallen at least 1 percent in nine straight sessions, the first time that’s happened since 2008.

Evidence of a top isn’t hard to find, if you go looking. Nasdaq valuations are 25 times earnings after a 10 percent plunge. The S&P 500 is in the 10th year of a rally that has paid 18 percent annualized to anyone who bought and held at the bottom. If January turns out to be the market’s swansong, its 5.6 percent gain would qualify in the 91 percentile of monthly returns since the turn of the century -- a decent way to go out.

“You could say, ‘I don’t care if it’s the 7th or 9th inning of the bull market, I’m getting out,’" Andrew Slimmon, senior portfolio manager and managing director at Morgan Stanley Investment Management, said by phone. “But returns in that final leg are really big.”