Bear Markets And The Biggest Fool’s Errand

This scarcely bears mentioning, but considering what stocks, rates and, increasingly, analysts, are saying about the proximity of a US recession, I thought I’d reiterate the point: Market timing is extremely perilous.

One of the most amusing observable phenomena in the financial universe is the tension between the necessity (it’s almost a requirement) of pretending it’s possible to beat the market and copious evidence to the contrary.

You could pretty easily argue that if it’s ironclad “laws” you’re after, and the subject is investing, about the closest you can come to an immutable truth is the assertion that, over any appreciable time frame, it’s very difficult to outperform a buy and hold strategy with dividends reinvested.

When you factor in the fees associated with active management (or, if you’re a self-directed investor, the psychological toll exacted by the market gods as punishment for insisting you possess superhuman prescience they didn’t confer upon you), the prospect of long run outperformance is almost laughable.

We all know this, but nobody says it, because otherwise, what are we doing? If we admit that the best strategy is no strategy, then there’s nothing else to talk about. Of course, we actually do admit it. The admission is in our IRAs.

As usual, I’ve buried the lede, although mercifully not too deep. You’re only 200 words in, believe it or not.

The point here is to highlight a familiar set of statistics which underscore just how dangerous it really is to play at market timing. Somewhat ironically, the figures were rolled out by Goldman in a new strategy note.

If you successfully avoided the most negative month in every calendar year going back more than a century (a feat we can fairly call impossible), your returns in equities would’ve been markedly higher. Specifically, you’d have delivered an 18% annualized return versus 10% with no market timing (figure below).

Again, I’d emphasize that avoiding the worst month every year since William McKinley is a feat that exists purely in the realm of the theoretical.

By contrast, it’s eminently possible that, if you troubled yourself to avoid losing months, you might very well end up missing quite a few of the biggest counter-trend rallies. Just ask anyone who was forced to chase in late March. As the same figure (above) makes clear, missing the best months would’ve resulted in positively horrible returns. In fact, at just 1.5%, returns would’ve been almost negatively horrible.

As Goldman’s Christian Mueller-Glissmann wrote Friday, missing the best month for stocks would’ve “remov[ed] all of the equity risk premium, resulting in lower returns than for US 10-year bonds.”

If you’re wondering whether it’s easier to time bear markets around recessions (that sounds plausible, right?), the answer is “no.” Indeed, market timing is ever harder in and around downturns.

“Once a recession starts equity returns turn more negative on average and show negative skew, but one year before a recession the distribution of equity returns is usually similar to the unconditional one,” Mueller-Glissmann went on to say, referencing the visual (below).

Goldman did manage to extract something like a playbook, but I think it’s entirely fair to say the average investor should exercise caution in attempting to stick this particular landing.

“On average equities tend to have the lowest monthly returns in the ‘early recession’ phase, which is when growth momentum turns negative but levels are still positive,” Mueller-Glissmann explained, before suggesting you’d need to be pretty careful to identify the inflection point, because “during late recession there are some of the most positive equity returns as the market anticipates the recovery, again well before a recession ends.”

Suffice to say market timing, like central banking, can be an endeavor that invites hard landings.

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11 thoughts on “Bear Markets And The Biggest Fool’s Errand

  1. Philosophical Economics has a blog (lately inactive) that has three articles from 2016 about timing recessions and markets. They are classics. Even if you find them too mathy, it is easy skip to the conclusions that he reaches after each section. Well worth googling.

  2. H-Man, not sure I agree with the market timing premise being foolhardy. Sure with a long enough time horizon, being long equities makes sense. But as that time horizon shortens, being long into an avalanche is not the best strategy. It really becomes a strategy of deploying assets based upon whatever risk/reward model you follow. It also assumes that you know how to short any particular market which is out of favor. Being long vol in February and March of 2020 was a winning strategy, being long vol when equities recovered in March was a loser. As T. Boone Pickens once said investments are like trains or buses, there is one leaving every couple of minutes.

    1. Test part one:


      H-man recently sold some Bitcoin and bought some Energy. Probably an example of most excellent “market timing.” Instead of couching this tired old bit of financial clickbait as market timing, recast it as risk management, and compare the thought experiment’s conclusions. Imagine you are about to retire and pondering drawdown rates. Imagine you are retired. Imagine you find yourself in a position where principal preservation is paramount. Why? IDK, maybe you like eating? The vast majority of trades are now executed by algos. It is probably reasonable to assume most of those trades are not considering the pros of buying and holding (B&H) for the long term returns. The sad fact is CPI kills your stock market returns. The sad fact is most carbon based investors only have a very small holding period compared to the time frames used to justify B&H theory. The sad fact is most retirees have to spend what ever income their portfolio throws off, meaning, their portfolio’s price line chart can never have the glorious positive slope their investment advisor brochures display. Subtract CPI from that portfolio price line and it starts looking pretty limp. But it gets worse this April of 2022. See the visual aids in the Bloomberg article 4/12/2022 by Lu Wang titled,

      “Valuation Bloat in Stocks and Bonds Is Catching Up With the Bull Market”

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